Amid all the proposals debated as part of a comprehensive U.S. energy bill this year was a relatively small provision that would open the door to much broader investment in midstream master limited partnerships (MLPs). The Coalition of Publicly Traded Partnerships, a Washington-based trade association that represents MLPs and related firms, has been lobbying for legislation that would allow mutual funds to directly purchase MLP units. The group hoped its proposal would be tacked onto the bill this fall. "We have not found any member [of Congress] who disagrees with the [MLP] proposal," says Mary Lyman, general counsel for the coalition. "The problem is attaching it to a vehicle that will get passed." The coalition's idea is relatively simple. Mutual funds are required to obtain 90% of their income from specific sources listed in the tax code, or lose their "regulated investment company" tax status. Publicly traded partnerships, such as midstream MLPs, are not on the list of qualifying income sources, largely because they did not exist when these rules were written, according to the coalition. The coalition wants to add these partnerships to the list of qualifying sources, so that mutual funds can invest in them more freely. "[The proposal] is too small to have momentum to get passed on its own. It needs to be attached to a larger bill," Lyman says. However, it's then a hostage to whatever larger, controversial issues may plague the overall bill. In 1999, the legislation was attached to a tax bill that passed the House and Senate, but was vetoed by President Clinton. For MLPs, increased access to institutional markets would open all sorts of capital-raising possibilities. But would mutual funds take the bait? Yes, observers say, but maybe not right away. With the demise of many energy merchant companies, some mutual fund investors are likely to be underexposed to the energy midstream sector, says Mark Easterbrook, an analyst with RBC Capital Markets. MLPs' performance should be attractive. They grew their distributions an average of 11% annually from 1997 to 2002. Though Easterbrook believes that growth should slow to 5% or 6% over time, they are still more attractive than certain other investments out there. However, even if this legislation were passed tomorrow, it would not be an overnight, universal remedy to attracting institutions to buy MLP units, Easterbrook adds. "There are several remaining, unappealing issues for mutual funds to handle with an investment in MLP units. We believe with the passing of this legislation, [mutual funds] will have to go through an education process, so institutional ownership of MLPs may take some time" Two MLPs-Kinder Morgan Energy Partners and Enbridge Energy Partners-have worked around the restrictions and created investment vehicles that are open to institutional investors. However, the success of these efforts is questionable. The two partnerships created new companies-Kinder Morgan Management LLC and Enbridge Energy Management LLC-that give institutions exposure to the MLPs, but pay their dividends in stock rather than cash. These "I-units" have not really caught on in the marketplace, says John Tysseland, an analyst with Raymond James. They trade at steep discounts to their MLP counterparts, indicating that investors may prefer cash dividends to additional shares. -Jodi Wetuski
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