Some investors frustrated by low yields and looking for alternatives have stumbled onto a class of securities called “Master Limited Partnerships” because of their high yields. The “Alerian Index” of these securities recently had distributions of about 7%. However, these securities aren’t risk-free.

MLPs are a confusing class of securities because they are listed on stock exchanges, but they aren’t stocks; they pay distributions that look like dividends but aren’t; and they have more complex tax implications for investors than stocks. To be an MLP a firm must satisfy stringent IRS requirements including that 90% of the firm’s income comes from businesses like energy.

For investors, one advantage is they are required to make quarterly distributions. Since they are partnerships, they avoid corporate income taxes at both the federal and state level. The income stream is still taxed once, to the individual investor. However, a significant part of the distribution is a tax-deferred return of capital. This means investors can avoid paying taxes on that part of the distribution until the MLP is sold but it results in complex record keeping. Unfortunately, along with these impressive distributions, longer-term returns have been unimpressive; for example, the index’s 3-, 5- and 10-year returns have been respectively 2.1%, -2.7% and -.3%. The year-to-date return is impressive at 29%.

Three types of MLPs

There are three relatively distinct types of MLPs: the "upstream," "midstream" and "downstream” MLPs. Upstream MLPs either actively drill for oil or gas, or supply services to firms that do. Midstream MLPs take the oil or gas from the drilling companies, transport it by pipeline to refineries or gas processing plants, and then store or transport the processed products to distribution centers. The downstream companies store and distribute the refined products to users.

Each of these three classes of MLPs earns money in dissimilar ways and this causes different risk/reward profiles.

Upstream MLPs' profits are directly tied to the prices of oil and natural gas. In 2015-16, when oil prices were exceptionally weak, their profits disappeared or turned into losses, sometimes requiring cuts to or elimination of distributions and even bankruptcy. However, with the recent $120 price for a barrel oil, the short-term looks bright.

Midstream MLPs are “toll roads” that transport oil and natural gas for a fixed cost under long-term contracts, usually with an inflation escalator. Thus, they are not directly affected by commodity prices. However, they are affected by changes in the volume of oil and gas they transport. The prices of these should be more stable than upstream MLPs.

Downstream MLPs, like companies that supply propane or gasoline to end users, are affected by demand for their products not commodity prices. They buy the product and then mark up the price. However, when commodity prices significantly rise, product prices rise, pressuring end-user demand.

Moderate investors interested in energy MLPs should concentrate on the midstream or downstream; more aggressive ones could consider upstream MLPs. However, they should realize that $120 a barrel oil won’t last forever and when if and when prices return to pre-war levels, upstream MLPs prices will come under pressure.

All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl@tampabay.rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.

This article originally appeared on Sarasota Herald-Tribune: ROBERT STEPLEMAN: Here's a primer on 'Master Limited Partnerships'