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By Christine Benz and Robert Goldsborough | 11-18-2015 02:00 PM

Tap Into Unloved MLPs Using Exchange-Traded Notes

Because of their tax structure and low fees, exchange-traded notes are among the best ways to gain exposure to master limited partnerships, says Morningstar's Bob Goldsborough.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. After soaring for the better part of this decade, master limited partnerships have recently come back down to earth. Joining me to discuss this sector and to share some potential fund ideas is Robert Goldsborough--he is an analyst with Morningstar.

Bob, thank you so much for being here.

Robert Goldsborough: Thank you, Christine.

Benz: Bob, at a very basic level, what are MLPs--master limited partnerships--and how are they different from owning dividend-paying common stocks?

Goldsborough: Master limited partnerships are companies that are set up to own and manage energy infrastructure assets, such as oil and gas pipelines and oil and gas storage facilities. They are a relatively new asset class, and they generate very high yields as well. But the way they are structured is that because they are partnerships they pay out almost all of their income to their unitholders. As a result, they have generated very high dividends--much higher than most dividend stocks.

Benz: Recently, we have seen the MLP sector come down quite a bit. I think it's interesting because, prior to this happening, people had thought because MLPs are just transporting oil and gas that they would be relatively impervious to commodity-price declines. In reality, it hasn't played out that way.

Goldsborough: It sure hasn't. This year has been a really rough year. Really, ever since energy prices began declining, these MLPs have really been hurt. That's been for a couple of reasons. One has been clearly that the commodity-price decline has hurt investor sentiment, but it also has hurt their economics. About one fourth of MLPs' cash flows are directly linked to commodity prices. So, they turned out to be not as impervious as everyone thought. On top of that, MLP investors have been spooked by the potential for rising interest rates and how that would impact MLPs. It flows through in a couple of different ways. One involves the fact that debt-financing costs would go up for new pipeline projects. But then, secondly, MLP yields would be at risk because their cost of capital would go up; that, in turn, might make an MLP look, on a relative basis, less appealing versus some other income vehicles.

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