MLP's

MLPs are rallying—but they're still risky

• BY AMEY STONE , 
• BARRON'S 
• – 04/23/2016

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Investors who bought master limited partnerships years ago, thinking they had found a high-yielding bond substitute with tax advantages, have been sorely tried. Those who held on through the 18-month downturn have gotten some welcome relief these past 10 weeks as the sector rebounded from its staggering 60% plunge from 2014 highs.

MLPs are now up 45% off mid-February lows, but the sector is still fraught with risk. MLPs continue to trade as if joined at the hip with crude. That has been a plus lately, but could turn negative just as quickly. Bullish trends such as shrinking U.S. production and the start of summer driving season could turn bearish if foreign producers boost production, which they've hinted they may do. Oil, now at $44 a barrel, is "likely to remain within a broad trading range," according to U.S. Bank Wealth Management.

We do not think the current MLP model is going to be the model of the future."

JOSHUA KOHN, CENTERSQUARE

MLP earnings season is just starting, and so far it's not a pretty picture. Pipeline giant Kinder Morgan ( KM I

, technically no longer an MLP, cut guidance and capital spending and indicated that robust growth wouldn't resume until 2018. NGL Energy Part

Meantime, more oil companies are going bankrupt, and MLPs are renegotiating contracts to provide more favorable terms. The ill-fated proposed merger of Williams ( WMB 

) and Energy Transfer Equity ( ETE 

) could come undone at any time. There are pockets of overcapacity in the U.S.' pipeline infrastructure, while new development is needed in others.

"Not every MLP is going to be a winner," says Libby Toudouze, portfolio manager at Cushing Asset Management, which runs the Mainstay Cushing MLP Premier fund ( CSHAX  | Get Prospectus 

). She sees this as a great time to buy, but says investors need to understand this not a fixed-income play. "Still, a 10% distribution is a pretty nice cushion to handle the volatility of equity markets," she says.

MLPs need two conditions to prosper, says Richard Daskin, who subadvises an MLP portfolio for Cumberland Advisors: "Capital markets have to be open, and energy prices have to be stable." Since MLPs pay out the majority of their cash flows to investors, they need to access capital markets to grow. Daskin is "reasonably confident" that MLPs will be higher in three years, but says "you have to go in with your eyes wide open." He recommends sticking to larger firms with strong sponsors and stable customers.

"We do not think the current MLP model is going to be the model of the future," says Joshua Kohn, portfolio manager of CenterSquare Investment Management's Dreyfus Global Infrastructure fund ( DGANX  | Get Prospectus 

), which has about 10% of its assets in pipelines. "Companies are going to need to retain more cash flow to have the flexibility to fund projects internally." His fund, which also invests in income-producing assets like utilities, airports, and toll roads, has a 3% yield and is up 6% this year.

A diversified infrastructure fund may be a better way for income investors to gain exposure to the commodity price rebound, suggests David Wright, manager of Sierra Strategic Income ( SSIZX  | Get Prospectus )

		, up 7% year to date. Closed-end funds that focus on infrastructure are trading at wide discounts and have higher yields. Jim Robinson, of Robinson Capital Management, has a position in Cohen & Steers Infrastructure ( UTF

), which has an 8% yield and a 15% discount.

Toudouze believes that investors who go with a broader infrastructure fund will miss out on future growth of the still immature U.S. pipeline industry. "Infrastructure has a very different risk-and-return profile," she says. But for beleaguered MLP investors, less risk may be just what they're looking for.