Kinder’s Departure No Threat To MLP Funds

While short-term tax implications are real, interest in the MLP space isn’t going away.

Kinder Morgan’s likely departure from the leading MLP ETP is big news, but it doesn’t spell doom for the fund, nor for exchange-traded products focused on MLPs.

The Alerian MLP ETF (AMLP) holds some 11 percent in Kinder Morgan Energy Partners and 3 percent in El Paso Pipeline Partners, and the departure of these MLPs could cause unpleasant tax effects for the fund and its investors.

Still, this news represents an evolutionary, not revolutionary, change in this dynamic space. Kinder has simply outgrown the MLP structure in the eyes of its management—it feels the new structure will be simpler to run and easier to grow—and has opted out.

So, what does this mean for the 120 or so MLPs that remain in the space?

The immediate market response was overwhelmingly positive: AMLP moved sharply up on Monday morning, swelling on the valuation of Kinder entities and non-Kinder entities alike. Kinder entities rose on the offer terms from their parent, while the other players in the space benefited from the possibility of being acquired by Kinder, presumably at a premium.

They might also have benefited from the zero-sum nature of index investing—dollars out of Kinder entities mean buying pressure from ETFs and mutual funds on those that remain.

For investors in the MLP ETP space, this immediate good news was tempered by two new risks. First, the tax picture—notoriously complex in the MLP space to begin with—got more complicated, as noted above.

This risk continues in a more diffuse nature if Kinder indeed snaps up smaller MLPs following its restructuring. Secondly, the pool of MLPs, already small at 120 or so, may shrink for the same reason. While this may continue to help valuations in the short run, the risk of too many dollars chasing too few firms increases.

I’d argue, however, that the remaining mix of risk and opportunity remains unchanged for MLP ETPs. It starts with a two-pronged investment thesis: income; and participation in the North American energy renaissance. I don’t see interest in these two drivers weakening anytime soon, rate-risk notwithstanding.

The remaining risks in the MLP ETP space—reasonably well known to prudent investors in the space—aren’t affected by the Kinder move beyond what’s described above:

• Structural and tax complexity
• Valuation complexity relative to vanilla equities
• Sensitivity to interest rate changes
• For MLP unit holders, no voting rights and no fiduciary duty from GP

Regulatory risk—the change that lawmakers might strip the MLP structure of its tax-deferred pass-through status—isn’t increased by the Kinder move either, in my view.

Instead, I see it as slightly lessened: Why should Congress bust up the structure when one of the largest players has just voluntarily opted into corporate taxation? Besides, Congress is—one hopes—more focused on losses to the Treasury from inversion.

In short, some MLP ETF investors may not be pleased with the capital gains distribution, and understandably so. Still, Kinder’s departure doesn’t signal the end of AMLP or of master limited partnership ETPs in general.

At the time this article was written, the author held no positions in the security mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.