This article was originally published on The DIV-net on May 7, 2009

I continue to believe that every asset class has its significance and its own importance. Every asset class has a role to play in investment portfolios. However, individual investors need to understand these factors in the context of their own portfolios. Being a do-it-yourself investor, I like to ignore the market noise and understand how any asset class will affect my portfolio objectives. In earlier posts, I have discussed about my investing approach with respect to commodity asset class, international developed/emerging asset class, and the investment vehicles that I like to use.

Master Limited Partnership (MLP) is another asset class that provides relatively higher yields than compared to commonly known dividends. MLPs were established by congressional act in mid-to-late 1980s to increase investments in energy and natural resource projects. If not always, then in most of cases, there are the companies that are engages in exploration, production, mining, processing, refining, marketing or transportation of mineral and natural resources. These natural resources could be oil, coal, propane, natural gas, timber, etc. Among other, MLP asset class has three significant differences when compared to corporate equities. These differences are:

Cash Distribution (and not cash dividends): The cash paid by MLPs to it’s until holders is known as distributions (and not dividends) which come from “distributable cash flow”. The distributable cash flow consists of MLPs entire cash flow less expenses such as operations, maintenance, and debt servicing. After looking at about five to eight MLPs, it was difficult for me to understand how companies determine distributable cash flow. There was no consistency across multiple MLPs. This lack of consistency makes it difficult to understand its ability to continually pay and raise distribution. For example, the cash flow can be increased by selling partnerships units and/or taking debts. In addition, distribution is increased without any increase is operational cash flow (or operational income?). It is not clear to me how the distributions are continually increased.

Tax Structure: MLPs operate as partnerships (instead of corporations). Therefore, they pass on their income to their unit holders. In this way, collectively the partnership does not pay tax. This is called favorable taxation. There is another school of thought that says since MLPs do not pay tax, there is more cash available for distribution.