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Special Energy Funds Triple Treasury Yields

NEW YORK (TheStreet) -- Funds that invest in master limited partnerships returned more than 80% last year and added another 10% so far in 2010, a striking result when many fund categories have sunk into the red. Can the good news continue? Perhaps.

MLPs, which typically invest in energy pipelines and other vital infrastructure, are reporting solid revenues. But short-term investors should be cautious. Some funds now sell for a premium above the value of their net assets.

MLPs have been attracting attention because of their yields. Many funds currently distribute yields of more than 7%, an attractive payout at a time utility stocks yield less than 4% and 10-year Treasuries yield 2.75%. Most MLPs have proved to be rock-solid income producers, paying out steady distributions year after year.

The income tends to be reliable. A typical partnership buries a pipeline deep underground and charges oil or gas companies to use it. The fees are based on the volume of material that travels through the system -- not on the price of energy. Pipeline users often sign contracts for 10 years or longer and agree to increase their fees along with inflation.

Under the rules, an MLP need not pay corporate taxes as long as it distributes most income to shareholders who must file returns. However, the IRS treats most distributions as a return of capital. So investors who get 7% distributions this year may avoid paying taxes next April 15 -- and they may be able to defer paying the IRS for years.

Despite the obvious appeal of MLPs, they have been a niche product partly because of their paperwork requirements. Owners of the stocks must file partnership tax returns, and they may need to file tax returns in every state where the partnership does business. Since some pipelines run through more than a dozen states, the paperwork can be enormous. As a result, most owners of shares in MLPs have been wealthy individuals from energy states.

In recent years, some closed-end funds began investing in MLPs. The funds enable shareholders to collect income from the partnerships and avoid most of the paperwork. During the downturn of 2008, the funds sank along with the stock market, then rocketed last year as investors sought yield. Seeing the big returns and rich yields, several companies have launched closed-end funds recently. Newcomers include ClearBridge Energy MLP (CEM) and Tortoise MLP Fund (NTG).

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