MLPs can only be used for ventures that derive 90%+ of their cash flows from real estate, natural resources or commodities. There are many tax benefits as well, combining the benefits of a limited partnership with the liquidity of a publicly traded company. In May 2010 the first ever MLP mutual fund was launched with a 7.8% distribution yield, which is higher than most equity alternatives such as REITs and Utilities. The vast majority of MLPs are pipeline businesses that earn a stable income from the transport of oil, gasoline and natural gas.

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Moreover, MLPs have appealed to investors for two reasons: high tax favored yields and a play on the U.S. energy boom. As of December 31, 2013, 110 of 135 MLPs were energy firms consisting of an MLP market cap of $491.3 billion.

MLP mutual funds are a great choice for investors seeking attractive yields that typically fall between 5% and 7% with the added tax benefits for these yields. They can be bought and sold using a regular brokerage and they give exposure to the market, as an MLP mutual fund can rise or fall along with the market just like a stock. An MLP can also trade at a premium or discount to its NAV.

As with any investment, there are risks with MLP mutual funds. Because MLPs must operate in certain industries, they can be overexposed to that industry, which is typically energy. Energy is cyclical and as oil prices rise and fall so does the MLP, even if it is a mutual fund providing some form of diversification.

Furthermore, while MLPs on their own aren’t subject to federal tax, mutual funds that hold the partnerships don’t enjoy the same advantage, which weighs on returns. Investors may still choose to go with MLP mutual funds rather than regular MLPs due to the convenience. It is important to note that individual investors that invest in MLP mutual funds get a big portion of the distributions at a tax advantage, allowing investors to put off tax bills until they sell, which eventually makes them eligible for lower, long-term capital gain rates.

Lastly, MLPs are managed by a general partner and the limited partners pay a fee for this service. The management expense fee can be relatively high so be sure to look at the MER before making any investment. At the same time, it is in the general partner’s interest to grow the MLP’s earnings and increase distributions.

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MLP mutual funds offer diversification benefits regular MLPs do not offer and can be a great contributor to a balanced portfolio of equities and bonds. They do not correlate strongly to other asset classes, which is a plus, and they also give exposure to the U.S. energy sector, and are highly tradable, with increases in demand for MLPs improving liquidity.

MLPs combine the tax benefits of a limited partnership with the liquidity of publicly traded securities. MLPs are unique in that they are not corporations and do not pay tax, therefore owners of a partnership are only taxed once—at the individual level—rather than twice, as compared to corporations, which pay taxes at the corporate level and again on the personal level when earnings are received as dividends.

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The benefit is that because MLPs do not pay corporate taxes, there are more earnings to be available to the investor. Furthermore, the distributions are treated as a form of tax-deferred return of capital. As distributions are received as return of capital, it also reduces the tax basis of the partnership units and these are not taxed at the investor’s current income. This occurs until you’ve gotten back the full amount of your original investment. Not only are you receiving several percent a year, you’re not paying taxes on it either.

The tax implications for MLPs are complex and it’s recommended to hire an accountant to get more information and also to deal with the extra paperwork involved. Investors will receive a K-1 for, which will reflect the investor’s share of income and losses of the MLP and must be included on the tax return. Also, MLPs are not attractive in tax-deferred IRAs because the partnership may generate taxable income in any given year.

Just as with mutual funds, there are many different kinds of MLP Mutual Funds. Here are some of the largest according to U.S. News Money:

• Oppenheimer SteelPath MLP Select 40 Fund (MLPFX)
• Oppenheimer SteelPath MLP Alpha Fund (MLPAX)
• Oppenheimer SteelPath MLP Income Fund (MLPDX)
• Center Coast MLP Focus Fund (CCCAX)
• Goldman Sachs MLP Energy Infrastructure Fund (GLPAX)
• MainStay Cushing MLP Premier Fund (CSHAX)

MLP mutual funds offer a great choice for income-oriented investors seeking attractive yields and tax favorable treatment. Keep in mind that there is an additional tax burden, and it is primarily focused on the energy sector, but MLP mutual funds as part of a well balanced portfolio can add additional returns. They are one of the most tax efficient vehicles available to the investing public. But with any investment, be sure to do your own due diligence and understand the underlying business before making an investment in MLP mutual funds.

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