As luck would have it, the Schedule K-1—traditionally considered the woebegone red-headed stepchild of the MLP asset class—just might hold some charm for investors, after all.

Speaking during a panel at the 13th annual National Association of Publicly Traded Partnerships’ (NAPTP) investor conference—probably the biggest MLP investor event of the year—Greg Reid, managing director and president/CEO of the MLP practice at Salient Capital Advisors LLC in Houston, said the arduous tax form could actually boost the class. Reid was part of a discussion detailing the flow of money into MLPs.

“I’ve come to realize the K-1, with all of its complexity, is actually your best friend,” he said. “It keeps a barrier of intrigue around the asset class that preserves higher rates of returns for those that are in the asset class.”

Long the bane of MLP investors, the K-1 of the Internal Revenue Service (IRS) is the tax document investors use to show their individual share of partnership income, gain and loss, deductions and credits. Unlike a Form 1099, which is typically issued in January, the K-1 is more often released later in the spring, which can delay tax filings.

But it’s the schedule’s reputation for complexity that can thin the herd of investors.

MLP moats

“Those are all competitive advantages because at the end of the day, we all want returns as investors,” Reid said. “So you want some barriers or moats around the asset class to protect you and hopefully, you enjoy higher rates of return in the long run.”

There was plenty for investors to enjoy at the conference, which beckoned almost 1,000 people to sunny and mild Jacksonville, Fla., where the strength of the midstream sector was evident.

The May conference, held outside the greater New York City area for the first time, presented an opportunity for MLPs to lay out their recent history and plans for the future before high-networth individuals, investment bankers and institutional investors. Presentations described by top executives from the likes of Kinder Morgan Energy Partners LP, Enterprise Products Partners LP, Spectra Energy Partners LP, MarkWest Energy Partners LP, Targa Resources Partners LP and Plains All American Pipeline Partners LP took on the pace of spontaneous investor conference calls.

Patterns began to emerge: MLPs are weighing the drop-down opportunities from their general partners; investors want distributions in the double digits; and most were confident that both dropdowns and higher distributions are on the horizon.

As such, Hinds Howard, vice president and senior financial analyst at CBRE Clarion Securities, said in his weekly investor note following the conference, “There is typically not much in the way of new news, and institutional investors like me have already met with or seen most of the management teams in the space within the last six months.”

Assessing investment

“But, it’s the best conference in terms of hallway conversation and assessing institutional investor sentiment, given the amount of bankers and large investors that show up,” he added.

Ethan Bellamy, senior research analyst at Robert W. Baird in Colorado, might have said it best when he described the scene at Jacksonville’s Sawgrass Marriott Golf Resort & Spa in a June note to investors.

“With equities up, MLP sector [enterprise value] above $1 trillion, rates down and oil above $100 [per barrel], there were many happy folks walking around the annual NAPTP meeting,” he wrote.

To be sure, the tempo was upbeat. Whether you’re looking at how many MLP units are currently trading on the market—almost 8 billion today, which is up from 1.4 billion in 2005—or the emergence of institutional investors in the space, MLPs are awash in good fortune.

Howard said his team left the conference with a positive sense of the growth opportunities available to certain MLPs and the continued growth of institutional ownership in the MLP space. Among the other highlights Howard noted:

  • “Management bashing” by other management teams will become more prevalent as MLPs compete more directly for capital;
  • The basin of choice, when there is a choice, is the Permian; and
  • Exports are needed to balance the condensate market.

PLR pause

Other issues confronting the sector included the decision this summer by the IRS to pause its issuance of private letter rulings (PLRs). Some potential MLPs choose to check with the IRS before filing if their income doesn’t come from traditional midstream sources.

Ryan Carney, a partner in the Houston tax practice of Vinson & Elkins LLP, said the fact that the IRS has put a hold on PLRs “is not devastating” because not every MLP needs the extra guidance. The IRS, however, did need to review its process on granting the rulings, he said. During the first 20 years of MLPs’ existence, only 30 PLRs were requested. Since 2008, about 75 requests have been presented.

“That exponential growth has gotten their attention,” he said during a panel on tax issues. Carney explained that some advisers in tax circles believed the IRS risked expanding the definition of what makes an MLP “by creed.”

With the relatively sudden outpouring of production from unconventional resource plays in the U.S. and Canada, midstream infrastructure is playing a bit of catchup to its upstream counterparts. As such, billions of dollars are expected to be invested in the midstream, mostly through MLP-structured businesses. In 2013, a record 21 MLPs filed their first IPOs.

But the question of whether capital markets can keep up with demand remains, said Darren Schuringa, managing partner at Yorkville Capital Management.

“We think so,” he said during the money flow panel. “We’ve seen yields rise, and we’ve seen the creation of new funds and institutional investors coming in. We’ve seen the cost of capital coming down.”

Good news

Wells Fargo investment advisers said in a June review of the conference that NAPTP brought good news to the financial side of MLPs.

“Over the past few months, there has been a progression of new [potential] structures and securities that could broaden the ownership pool and facilitate investment in the MLP sector,” Wells Fargo analysts said. “These include the Up-C structure, OPCO entities, royalty trust/MLP crossbreed, creation of IDRs [issues default ratings] post IPO, sidecar vehicle and others. We expect this trend to continue with new MLPs being formed, increased competition among partnerships for capital and MLPs seeking to optimize their cost of capital and gain a competitive advantage via their financial structures.”

In its quarterly snapshot, Oppenheimer Equity Research said investors remain “enamored” with energy MLPs for several reasons, including the upside macroeconomic backdrop and the ongoing U.S. energy revolution.

New capital

“MLPs continue to find new investors and sources of capital,” Opco said. “As the MLP universe expands in 2014 (albeit at a slower pace than 2013), we expect this trend to continue. As the group has evolved and gained market acceptance, the equities have generally marched higher, with higher quality and faster distribution growth leading to the most lofty valuations.”

During a panel discussion on money flowing into the MLP asset class, Chris Eades, managing director and portfolio manager at Clearbridge Investments LLC, said that just five years ago, MLPs were dominated by individual investors. Only about 20% was held by institutional investors, he said.

“At that point in time, it was all about yield. There was very little differentiation between the evaluations from a higher growth stock to a lower growth stock,” he said. “Yet as you roll the clock forward, the individual investors have become more sophisticated, more educated and now, I think investors are very aware that it’s not just the yield—growth is equally important in determining your return.”

But still, a word of warning from Bellamy at Baird.

“We are cautious in the face of such ebullience,” Bellamy said. “Our primary concerns for MLPs: the oil glut, created by production growth meeting an export ban, ill-equipped refiners and tepid demand. Investors should hope accommodative conditions persist but be prepared for a correction.”

Deon Daugherty can be reached at ddaugherty@hartenergy.com or 713-260-1065.