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Value in MLP Tax Structure



-- Posted Wednesday, 8 September 2010 | | Source: GoldSeek.com

Wunderlich Securities Senior Analyst Ethan Bellamy is another success story in a considerable line of exceptional MLP analysts. He focuses on about 15 MLP names, including a number of closed-end funds. He believes the tax advantages of the MLP structure will eventually allow MLPs to become a "stalwart" asset class. "Ultimately, capital is going to flow where it is best treated," he says, "MLPs offer pretty significant value propositions for an investor." In this exclusive interview with The Energy Report, Ethan talks about some unprecedented opportunities in the upstream MLP space.

The Energy Report: Today we're talking with Ethan Bellamy, an analyst with Wunderlich Securities. Ethan, please tell us about yourself and your coverage sector.

Ethan Bellamy: I started out as a junior analyst covering cable and media at Stifel Nicolaus and Co. Then I got a job covering MLPs before I was lured to the buy side at Lehman Brothers, which was a shorter-lived experience than I would've hoped. I've been with Wunderlich for two years. My coverage list is a gathering of direct MLPs and closed-end MLP funds. I cover about 15 names, everything from propane to coal to the closed-end funds to oil and gas production to pipelines. I've either owned, shorted or written research on just about every MLP out there.

TER: That's quite a range of MLP experience. Ethan, we've seen about a 25% increase in dollar volume flowing into MLPs this quarter versus the same quarter last year. What's driving that increase?

EB: Fund flows into MLPs can really be attributed to a bullish "perfect storm" phenomenon. First, you have the launch of two de novo MLP closed-end funds at more than $1 billion each. I wouldn't be surprised to see a short-term period of MLP underperformance as that capital deployment subsides.

The "perfect storm" is being further enhanced by the big macroeconomic trend we're seeing in U.S. Treasuries. The benchmark 10-year T-Bills just hit 2.5%. That means risk-free yields are really offering very little income, so investors are forced to look elsewhere.

We're also seeing significant fear of rising personal income tax rates for 2011 if Congress allows the Bush tax cuts to expire. With the additional taxes for "Obama Care," most people recognize that the cash from the "helicopter" stimulus plan we've had has to be paid by somebody. That somebody is going to be wage earners in the next two decades through higher taxes. On a relative basis, MLPs offer a tax-deferred income stream that looks a lot like municipal bonds; a municipal bond is tax exempt and MLPs are tax deferred until you sell. That looks pretty attractive to people considering the likelihood of higher taxes in the future.

TER: You're basically saying other investment vehicles could see more taxes, and thus it's better to be in MLPs because they likely won't be subject to the same taxes as other investments.

EB: There are taxes on MLPs but they are deferred until the time of sale; you recapture that depreciation expense upon sale. But in the interim you're getting an 80%–100% tax-deferred distribution stream, so your net present value with the investment is a lot higher.

TER: Ethan, I'm not sure most investors know the key differences between the closed-end funds and the open-end funds. Can you explain the basic differences?

EB: At the simplest level, closed-end funds are fixed pools of capital that trade on exchanges. You can have a secondary offering that will grow the pool of capital; otherwise it's fixed. You buy a share in that pool that is traded on an exchange. You can have premiums or discounts to the net asset value (NAV) of that closed-end fund based on how the shares are trading. With an open-end fund, it's a variable pool of capital that grows when you buy into it and declines when you redeem your shares. That's typically done daily through the fund manager.

In a closed-end fund you can have a discount of premium to NAV, while with an open-end vehicle you're buying or redeeming at the NAV every day. It's just basically two separate types of vehicles, both of which are popular.

TER: MLP ownership seems to be transitioning from retail to institutional investors. What do you think its ultimate result will be?

EB: I think and I hope that the ultimate result will be something similar to what's occurred with Real Estate Income Trusts (REITs), where as the asset class expanded and became more institutionalized, more specific management vehicles were set up to invest in the space and valuations and liquidity improved. Ultimately, it became a stalwart investment class. I think that's occurring with MLPs and it's likely to continue on an incremental basis over time.

The sea change we've seen lately is that the combination of returns and improved liquidity has made the sector too difficult to ignore. Ultimately capital is going to flow where it is best treated. MLPs certainly offer pretty significant value propositions for an investor. The other benefit is that the bigger and more entrenched the MLP sector gets, the less likely it is that something dramatic happens with the MLP tax structure. For example, no one questions the tax benefits of REITs because they are globalized, have been around for a while and the structure is in place.

TER: You like a number of closed-end MLP funds, but you also like a number of individual MLPs. Are investors best served by directly owning MLPs or owning units in a closed-end fund or a combination thereof? What's a good mix?

EB: There's something for everybody here. It really depends on whether you are deploying taxable or non-taxable funds. Meaning, are you buying in a taxable account or are you buying in an IRA or a 401K or Keogh Plan? You can buy MLPs directly in an IRA or another non-taxable account, but at certain thresholds those will generate unrelated taxable income on the income received, not necessarily on the distributions received. There is no prohibition against buying MLPs directly and holding them in an IRA. It just can present some additional taxes that may not be warranted. The most efficient thing you can do is buy MLPs directly and receive the benefits in a taxable account. But if you want to deploy capital in the MLP space and you don't want to directly track investments, and you're worried about generating unrelated taxable income, then you might want to choose a closed-end fund or an exchange-traded note (ETN), which produces a 1099 tax form. A closed-end fund basically gives you a diversified portfolio of MLPs, so you get some portfolio diversification benefits, as well.

TER: Do you have some parting thoughts on the MLP sector?

EB: I think in the near term there's some risk that you'll see a reversion toward the S&P 500, but long term I think it's pretty easy to be constructive on the MLP space. I think that we're going to see an inflationary environment essentially created by fiat money and big budget deficits. I don't think there's a really easy solution for the Fed to do anything but inflate our way out of the debt that we've created. In that type of environment, an MLP should do very well over the long term. Moreover, I think there's no way around higher personal income taxes. Frankly, most investors should be buying these for the long term because that's where the real benefit is, deferring as far out into the future as possible the taxes that will be due.

Ethan Bellamy specializes in the analysis of Master Limited Partnerships. Previously, he was the director of research for the Lehman Brothers MLP Opportunity Fund where he was responsible for fundamental analysis and due diligence in public, PIPE and pre-IPO investments in natural resources. Prior to joining Lehman Brothers, Ethan was a senior analyst covering MLPs at Stifel Nicolaus where his coverage included oil and natural gas production, gathering and transportation; propane distribution; marine shipping; coal mining; and MLP-oriented closed-end funds. Ethan previously worked as a journalist for various local and national media and taught writing and journalism at the University of Colorado at Boulder for two years. He was a doctoral student focusing on energy policy at the University of Colorado at Denver, with a focus on energy infrastructure and renewable energy policy. He holds an MA from the University of Colorado at Boulder and a BA from Clemson University. Ethan is an avid snowboarder and telemark skier, and has hiked both the Pacific Crest and Appalachian National Scenic Trails in their entirety.

Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.

From time to time, Streetwise Reports LLC and its  directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.


-- Posted Wednesday, 8 September 2010 | Digg This Article | Source: GoldSeek.com




 



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