Master Limited Partnerships Have Been the Source of Significant Losses for Investors

In the low interest rate environment of the past several years, master limited partnerships (MLPs) became quite popular and were promoted by brokers as investments that would earn a strong yield-based return while retaining the potential for capital appreciation.  MLP IPOs raised more than $100 billion since the global financial crisis.  Recently, however, the current values of many MLPs have plummeted (many by more than 50%) and the high yields have come to an end as falling energy prices and doubt about the future of the industry have caused the partnerships to suspend or decrease their dividends.  This has caught many investors—particularly those who replaced their relatively safe fixed-income investments with MLPs—by surprise as brokers tended to promote the supposed benefits of MLPs (including by referencing the high returns of the past) without adequate disclosure of the substantial risks associated with MLPs (such as their stock-like characteristics and high concentration in the energy industry).

What is a Master Limited Partnership?

A master limited partnership, which is sometimes referred to as a publicly traded partnership, is a limited partnership that is publicly traded on an exchange.  It seeks to combine the tax benefits of a limited partnership with the liquidity of a publicly traded security.  As a partnership, MLPs do not pay entity-level income taxes and instead pass all income, gains, deductions, losses, and credits through to investors.  Because they are publicly traded on an exchange, MLPs are available to any investor with a brokerage account and can be bought and sold throughout the trading day.

Today, MLPs are primarily concentrated in the energy sector.  MLPs first came about in the early 1980s (Apache Corporation became the first company to structure as an MLP in 1981).  At the time, there were no real restrictions on the types of businesses that could operate as MLPs.  As a result, companies all over the spectrum began to form as MLPs.  To prevent the loss of tax revenues, Congress passed legislation designed to restrict the types of companies that could form MLPs.  Now, to qualify as an MLP under the Internal Revenue Code, a partnership must generate at least 90 percent of its income from “qualifying” sources.  These “qualifying” sources generally include income related to the energy industry, such as those related to the exploration, production, processing, and transportation of oil, natural gas, and coal.

Unlike a real estate investment trust (REIT), MLPs do not have a statutory requirement to distribute a certain amount of its income to investors.  Because MLPs are typically valued based on a multiple of their cash flow, they tend to distribute all available cash (cash over and above that required for operations and debt service) to investors.  This, combined with absence of corporate taxes, has historically created the high-yield for investors.

MLPs generally have two categories of ownership:  the general partner and the limited partners.  The general partner’s ownership interest is typically held by a holding company owned by a major energy company.  The limited partners’ ownership interest is held by the investors and traded on an exchange. The general partner, although it generally owns a very small portion of the MLP compared to the combined value of the limited partners, controls and manages the MLP.

Investing in MLPs

The number of MLPs has more than tripled over the last ten years as the low interest rate environment has driven investor demand, and MLPs have raised more than $100 billion in IPOs since 2008.  According to Alerian (an independent provider of MLP and energy infrastructure market intelligence), as of December 31, 2015, there were 121 different MLPs with a total market capitalization of about $300 billion.  Just a year earlier, MLPs had a market capitalization of over $450 billion.

The top 10 MLPs (in terms of market capitalization) include Enterprise Products Partners, LP (EPD); Energy Transfer Partners, LP (ETP); Magellan Midstream Partners, LP (MMP); MPLX, LP (MPLX); Plains All American Pipeline, LP (PAA); Buckeye Partners, LP (BPL); Williams Partners, LP (WPZ); ONEOK Partners, LP (OKS); Enbridge Energy Partners, LP (EEP); Sunoco Logistics Partners, LP (SXL).

In addition to buying individual MLPs, investors may invest in MLPs through a variety of funds that invest in MLPs.  Investors may gain MLP investment exposure through exchange-traded funds (ETFs), mutual funds (open-end funds), closed end funds, and structured notes.  Although these products are available to retail investors, many are not easily understood, such as structured notes that are issued by and are the obligation of a financial institution, but have payoffs that are linked to the returns of an MLP index.

As global energy prices have declined over the past year, MLPs have suffered staggering losses.  The Alerian MLP Index, which tracks the performance of the 50 largest MLPs, declined by 32.6% in 2015. Not surprisingly, the returns of ETFs investing in MLPs have declined precipitously:  the Alerian MLP ETF (AMLP) lost 35.9% from January 1, 2015 to January 31, 2016.  Similarly, the Global X MLP ETF (MLPA) lost 39.2% over that timeframe.  Smaller MLPs suffered even greater losses: Atlas Energy (ATLS) lost a staggering 91.3%, Plains All American Pipeline (PAA) lost 54.4%, and Enbridge Energy Partners LP (EEP) lost 50.8%.  The following charts illustrate the dramatic losses suffered by MLP investors since 2015.

What are the risks of MLPs?

MLPs carry two primary risks:  stock-like characteristics and high concentration in one industry (energy).  First, they involve stock-like volatility and risk.  While they are promoted as fixed-income investments similar to bonds, an investment in MLPs represents an equity stake in the company.  Investors are subject to price movement of the MLPs and only share in profits after payment of debt (such as bond interest payments).  Investors replacing traditional fixed income investments (such as bonds) with MLPs may have unintentionally increased their portfolio’s volatility and risk profile.  Second, because of the legislation passed in the 1980s, MLPs are typically restricted to the energy sector.  Thus, MLPs have little diversification beyond different elements of the energy sector, and they will tend to rise and fall along with the price and volume of energy products being produced and sold.  Another less commonly discussed risk is lack of management control.  In a traditional corporation, the management is controlled, at least indirectly, by the voting power of the shareholders.  In an MLP, however, management is vested in the general partner.  Limited partners, despite the amount of interest in the MLP they may own, have very limited control over the management and operations of the MLP.

Many investors held portfolios that were overly concentrated to these products.  Even a diversified portfolio of MLPs remains heavily concentrated in exposure to the energy sector.  Additionally, structured notes contain counter-party risk and frequently use derivatives to embed leverage.

Here is a current list of MLPs and funds investing in MLPs by ticker symbol and name.  If you have invested in these products and suffered losses, we would like to speak with you.

Fishman Haygood represents investors who have suffered investment losses in claims against their brokers or financial advisors. Our experienced attorneys have brought securities fraud cases in state and federal courts across the nation, as well as in FINRA arbitration. We work to help investors recoup their losses.

Of course, all cases are different. For that reason, we analyze each client’s matter individually and provide our personalized evaluation only after considering all of the facts and circumstances of all possible claims. If you or someone you know is the victim of securities fraud, please contact a Fishman Haygood lawyer today.