Navigating a 'perfect storm' in MLP fundsNov. 19, 2012

By Murray Coleman

(This article was originally published Friday.)

--Income-hungry investors still putting money into MLP ETFs

--Managers point to strong long-term industry fundamentals

--Advisers see MLP valuations more attractive versus bonds

Investors aren't giving up on pipeline operators feeding America's push toward energy independence, despite a post-election market plunge

The dozen exchange-traded funds and sister exchange-traded notes tracking so-called master limited partnerships--which are designed to handle transportation and storage networks for oil, gas and other natural resources--had attracted net inflows of more than $27 million in the past week through Thursday.

Perhaps even more telling, those same MLP funds had gathered $200 million-plus since mid-October, says market researcher XTF Global.

But among those 12 funds, nine are non-levered funds whose shares had posted, on average, a nearly 7% drop since Nov. 7. From mid-October, those prices had tumbled more than 9%. In contrast, the Vanguard Total Stock Market ETF's /quotes/zigman/1477965/quotes/nls/vti VTI +0.32% shares had fallen about 2% in the past week and almost 6% over the last 30 trading sessions.

"MLPs are at the center of this country's build-out of its energy infrastructure and producers are still eager to get their products to market. But their stocks are getting whacked by some rather transient, non-fundamental issues," says Hinds Howard, chief investment officer at Guzman Investment Strategies. The start-up registered investment advisory firm in Coral Gables, Fla., manages about $15 million in assets and specializes in MLP investments.

Since a portion of the proceeds from selling MLP stocks can be counted as ordinary income by investors, the funds' recent drop is likely tied to concerns that tax rates could significantly rise next year, Mr. Howard notes. He also observes that it isn't unusual for investors to unload shares in November after companies make third-quarter distributions.

Another contributing factor: Strong demand for initial public offerings of MLPs is pressuring prices as more shares flood the market, Mr. Howard adds.

Along with Europe's ongoing sovereign debt crisis and uncertainty over global economic growth, a sort of "perfect storm" is hovering over the industry, says Austin Poirier, a senior investment advisor at Ballentine Partners. The firm, in Waltham, Mass., oversees $3.5 billion in assets.

Mr. Poirier estimates that an average MLP is yielding about 4.7 percentage points more than 10-year Treasury notes. "Historically, such a spread has traded around 3.3 points," he says. "So at current levels, MLPs appear undervalued."

As interest rates rise in coming years, yields on such stocks are likely to hold up better than most types of bonds, Mr. Poirier predicts. Managers at Ballentine Partners have been building positions in MLP stocks since mid-summer.

"The average investor is probably best served buying MLPs in an IRA (individual retirement account) through an ETN, which typically receives better tax treatment than an ETF since it represents a note tied to the performance of an underlying index and doesn't actually own securities," Mr. Poirier says.

Long-time MLP investor Matt Reiner, chief investment officer at Wela Strategies in Atlanta, is also viewing recent market dips as attractive entry points into the industry. The advisory shop manages $45 million in assets and is a spin-off of Capital Investment Advisors, which runs about $1 billion in assets.

In the past, Mr. Reiner favored the $4.9 billion JPMorgan Alerian MLP ETN /quotes/zigman/1524086/quotes/nls/amj AMJ -0.21% . Recently, he has shifted to the $412.3 million UBS E-TRACS Alerian MLP Infrastructure ETN /quotes/zigman/1541684/quotes/nls/mlpi MLPI -0.46% . Wela's managers also prefer ETNs over rival ETFs for tax reasons, Mr. Reiner says.

But he and Mr. Poirier both stress that investing in such unsecured debt notes requires extra research into an ETN issuer's credit worthiness.

Since MLP revenue is usually tied to long-term delivery and maintenance contracts, Mr. Reiner doesn't view recent pullbacks as a sign of significant industry headwinds.

"We're seeing a temporary mispricing in markets that investors with longer-term horizons should be able to use to their advantage," he says.