Gabriel Hammond is a fund manager from central casting. Raised in a posh Washington, D.C. suburb, he got a degree from Johns Hopkins, spent two years at Goldman Sachs and then set up his own fund firm (current assets under management: $250 million). The one kink in his story is that Hammond, 29, doesnt dabble in growth stocks or distressed debt. His game is rusty metal tubes buried deep underground. Hammonds Dallas firm, Alerian Capital Management, taps into oil and natural gas pipelines via tax-advantaged vehicles called master limited partnerships, or MLPs.  Every day 280,000 miles of pipelines shuttle 63 billion cubic feet of natural gas around the U.S. About a quarter of them are held as MLPs. A separate 100,000- mile network hauls 20 million barrels of crude daily, with 70% in MLP hands.  The 50 exchange-listed MLP pipelines and storage units have a combined value of $120 billion. Theres more capital en route. The U.S. is expected to put another $100 billion into its natural gas infrastructure over the next decade. The pipelines income streams should hold up even if energy prices drop. Thats because they get so much per pound shipped, not per dollar of product.  These companies are all toll-road business models, says Hammond. Theyre agnostic about whether crude oil is at $30 or $115 a barrel.  The partnerships are typically formed when big companies decide to raise cash by hiving off hard assets. Once public, MLPs trade like stocks. The twist is that theyre partnerships, which means they pass on earnings and depreciation to investors. Come tax time, that means investors typically pay ordinary income taxes on about one-fifth of distributions, which have grown 8% to 10% annually in recent years.  The other 80% of distributions are considered nontaxable returns of capital that reduce a partners cost basis. That means they turn into future capital gains, taxed either much later (when the investor sells the shares) or never, if it winds up in his estate and enjoys the capital gains step-up at death. There are some further subtleties (the tax treatment of partnerships is bizarrely complicated), but the bottom line is that investors holding MLPs that own depreciating assets are taxed leniently.  The downside of investing directly in MLPs is complexity. Pipeline partnerships are a particular problem because they must calculate, and investors must report, gains and losses in each state they traverse. The resulting K-1 tax forms are so cumbersome that many financial advisers suggest bothering with MLPs only for six-figure investments.  A simpler alternative is to own the exchange-traded iShares in one of two industry stalwarts, Kinder Morgan and Enbridge. These trade, and are taxed, like ETFs and require no K-1 filings. Kinder Morgan is the largest MLP by market cap at $15.2 billion; Enbridge is valued at $4.8 billion. They are precisely the sort of workhorse pipelines that Hammond favors ( see table).  In 1997, in Hammonds freshman year at college, he put $2,000 earned as a swimming instructor into his first online brokerage account and started trading. The tech bust was raging by the time he graduated in 2001 with a double major in economics and international relations. Yet Hammonds account had ballooned to $17,000, thanks to blue chips like Caterpillar and Altria.  After graduating, Hammond, who maintains his swimmers physique on a diet that includes a gallon of egg whites a week, took a job as an energy analyst at Goldman Sachs in New York. It turned out to be a front-row seat for Enrons collapse and the shock waves it sent through the pipeline industry. Companies were selling assets to stave off bankruptcy, recalls Hammond.  As firms like El Paso and Dynegy raced to raise capital, some spun off pipelines into MLPs. When it was over, Hammond was the only one in Goldmans energy and power group interested in covering the partnerships.  In the 15 years since tax changes had paved the way for modern MLPs, a mere 15 had been launched and had a combined value of $20 billion by 2003. In the market recovery that followed Enrons collapse, however, the partnerships started to draw yield-hungry investors. Hammond was convinced the MLP business was poised for a growth spurt, like the one REITs had enjoyed a decade and a half earlier.  He began putting together Alerian in July 2004 and trading MLPs with $5 million under management from Hans Utsch, a portfolio manager at Federated Investors, whom Hammond had met at a luncheon. Hammond struggled just to pay the bills but earned 15% his first half-year in operation. That was good enough to lure investments from two Wall Street firms, which declined to be named.  A year after Alerians launch Hammond had $50 million under management. His timing was outstanding. In the four years after he set up Alerian, the MLP sectors market cap tripled and Alerians total returns came in at 20% annually. In June 2006 Hammonds little firm launched the Alerian Master Limited Partnership Index, the first to track MLPs. A year later he added BearLinx Alerian MLP Select, an exchange-traded note that trades like an ETF and tracks the firms MLP index.  Despite MLPs hefty returns over the past decade, tax-exempt institutions have shied away from investing directly in them because of tax complications. (Its similarly a bad idea to hold MLPshares in a tax-deferred account.) But they are a fine choice, he says, for retail investors in high tax brackets who can stomach the paperwork.  MLP distributions average 7.5% of market prices today, or 3.6 percentage points more than yields on ten-year Treasurys. That compares with a historical average of only 2.25 points over Treasurys, says Stephen Maresca, an MLP analyst at UBS. No surprise, hes a bull on the sector.  Subscribe to Forbes and Save. Click Here.
You want a piece of the energy business that wonÂt get hurt if oil crashes? Take Gabriel HammondÂs advice and own some buried steel.