The Next Bubble: MLPs
NEW YORK (TheStreet) -- Over the past few years, investors have flocked to master limited partnerships like mosquitos to fire, and in my view, they could get burned if they aren't careful.
It's easy to see the appeal: purveyors of MLPs will point to the high yield and tax advantages. The story, however, is far more complicated, and as is often the case, riskier than described.
In case you aren't familiar with MLPs, essentially they are partnerships that are publicly traded. Investors in MLPs, like any other partnership, are considered unit holders.
Most MLPs, although not all, earn the majority of their income from energy-related companies -- think oil or natural-gas pipelines and you've pretty much got it.In fairness, I have never been a big fan of MLPs, or any other investment that returns my own principal and calls it income. After all, if it's my money that is being sent to me, it's hardly fair to call it income. So far, while interest rates have continued to trend downward, and financing for these companies has remained cheap, the risks of the investment haven't been outsized.
Caution SignsWith the likelihood of rising rates increasing, additional regulatory scrutiny and changing demand for use of energy -- both in terms of quantity as well as type, the risks for these vehicles are mounting. Let's start with the most obvious (and annoying) -- K1s. If you invest in an MLP, you won't receive a 1099, you will get a K1 which is likely to be taxed very differently and without the benefits of any potential offsetting deductions. Second, a part -- sometimes as much as half -- of the distribution you receive is actually a return of your own principal -- in other words, the actual yield is much lower than promoted.
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