ETFs tracking master limited partnerships continue to draw interest from investors searching high and low for yield.
It’s important for investors to do extra homework when considering ETFs following asset classes outside the traditional comfort zone of stocks and bonds.
MLPs are companies that are involved with the storage and transportation of commodities such as oil or natural gas, such as pipelines.
The sector has attracted attention in recent years due to above-average yields and diversification properties because it tends not to move in lockstep with the stock market.
“The operating income from the transportation of fuels tends to be much less volatile than the prices of energy commodities. As such, MLPs tend to be stable, relatively high income-generating assets,” says Morningstar analyst Abraham Bailin.
Exchange traded products for this asset class include JP Morgan Alerian MLP Index ETN (AMJ - News), Alerian MLP ETF (AMLP - News), Yorkville High Income MLP (YMLP - News) and Global X MLP (MLPA - News).
AMJ and AMLP are currently offering dividend yields in the 5% to 6% range.
MLPA sports the lowest expense ratio of the group at 0.45%, ETF Database notes.
However, in an analyst report on MLPA, Morningstar’s Bailin points out the ETF cuts the fee on MLP exposure but retains tax complications. MLPA is structured as a C-corp and is taxed at the entity level. As a result, investors in this fund are taxed twice, he said.
As always, investors are best served by consulting a tax advisor.
“The advantage of investing in an ETF made up of MLPs is that investors will receive one 1099 form. Those who invest in individual MLPs receive cumbersome K-1 forms, as MLPs are classified as partnerships by the IRS. However, unlike most investment companies, MLPA is structured as a C-corporation and is thus required to pay applicable, entity-level state and federal corporate income taxes. This facet of MLPA’s structure warrants strong investor caution,” Bailin wrote. “The fund will generally be liable to pay such taxes annually on the capital appreciation of its holdings and a small (10%-30%) share of the distributions that it receives from the MLPs.”
He added: “The distribution from the holdings of this fund are passed on to investors as dividends from MLPA. Because the fund pays annual corporate taxes, the net asset value is effectively decreased by the value of the tax. The index calculation does not account for tax deductions, so the fund will have tracking error.”
The benefits of MLPs include high current income, growing distributions, tax-advantaged income, and low correlation to broader asset classes, said Darren Schuringa of Yorkville ETF Advisors in a recent Forbes interview.
Alerian MLP Index ETN