Alternative Investment Series: There’s Money in the Midstream

By TradeSmith Editorial Staff

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When most investors think about alternative investments, they likely envision private equity firms, venture capitalists, and hedge funds. However, to qualify for these investment vehicles, participants need to be accredited investors.

An accredited investor is an individual who generates an annual income of more than $200,000 per year or has a total net worth (minus their primary home) of $1 million.

For most Americans, those levels are out of reach. But they can partake in alternative investments of a different kind.

As I mentioned yesterday, real estate investment trusts (REITs) are uniquely structured assets that allow ordinary investors to generate incredible returns by owning units in income-producing properties.

About 145 million Americans own REITs in retirement accounts, pension funds, and other structures. These publicly traded alternative assets can deliver incredible real returns by the growth and appreciation of their income streams.

But REITs aren’t the only option for investors like us. Today, I want to talk about another popular alternative investment that can deliver outstanding returns.

Welcome to the Midstream

The U.S. energy industry consists of three primary portions.

First, the upstream sector of the industry consists of the companies that pull oil, gas, and other liquids out of the ground.

The downstream sector consists of the companies that refine natural gas or crude oil into products like plastics, gasoline, and jet fuel. This portion also includes the gas stations where you fuel your car and the companies that deliver heating oil to your home.

But in the middle of this supply chain lies the midstream market.

This market consists of the companies that operate pipelines and fuel storage across an extensive network of operators. These operators connect the upstream producers to the downstream network. So in many ways, the supply chain acts as a bridge to move products from one place to another. And pipeline operators collect tolls on what they ship regardless of whether the underlying price of oil or gas is going up or down.

How to Exploit the Midstream

The midstream delivers one of the best investment assets for income-thirsty investors. This “best investment asset” is also one of the best “alternative” investment assets.

It’s called a master limited partnership, or an MLP.

Like a REIT, an MLP is a publicly traded alternative asset with different regulatory and structural benefits for investors. It combines the benefits of a limited partnership with the liquidity offered on an open stock market.

A tax law in 1986 initially defined a variety of tax benefits for companies like MLPs and REITs. For example, the partnership can legally “pass through” cash flow to investors without a stage of corporate taxes due to a specific requirement.

It must earn at least 90% of its income through energy, commodities, natural resources, or real estate activities. The MLP is structured between general partners and limited partners. These limited partners are the investors who can receive tax-sheltered quarterly dividend payments right to their accounts.

As the companies pass through this cash flow generated by their assets, the investors pay taxes as normal income. They also receive a nice pro rata share of the depreciation allowed to the MLP by the government.

Also, because these midstream companies are growing due to constant demand for fuels, investors can benefit from their financial growth. So, in addition to strong, reliable dividends, they can see their wealth accumulate from the appreciation of the share prices.

Energy is Common, But It’s Not the Only Investment

As I noted, the oil and gas midstream is typically where you’ll hear the names of MLPs. A few we’ve noted in the past include Enterprise Products Partners (EPD), Magellan Midstream Partners (MMP), and MPLX (MPLX).

But there are utility MLPs like Brookfield Infrastructure Partners (BIP) and Brookfield Renewable Partners (BEP) that generate 90% of their income and interest from various energy and infrastructure assets. Moreover, in the future, companies that generate large amounts of capital from green infrastructure like electric vehicle charging stations will likely form MLPs.

There are MLPs in the lumber and wood production industry (natural resources) and in thermal coal energy. And until 2018, there was even an MLP for cemeteries, called StoneMor (it rolled into an LLC that year).

MLPs create unique ways for retirement investors to generate income with high dividends. For example, EPD, mentioned above, pays a mouthwatering 8.17% dividend and just experienced a large round of insider buying. The MLP is in the Green Zone on TradeSmith Finance and is looking to break out of a recent side-trend. If you’re seeking a combination of growth and income, this may be the best option for the future.