Taxing The Wealthy Part II: MLP ETFs Experience A 'Double Whammy'

Includes: AMJ
by: Gary Gordon

Over the last 20+ years, my opinions have aroused emotional reactions from readers and listeners alike. And the forum — national talk radio, podcast, newspaper, magazine, digital ink — has been far less critical than the topics themselves.

For example, I was one of a handful of original ETF advocates in the mid-90s when few people valued trade-ability/liquidity. I was an “idiot, “jack-ass,” and a “hack” for expressing the importance of planning when to sell. After all, if Vanguard’s Bogle and Oprah’s Orman understood that buy-n-hold was the key to financial freedom, what gave me the right to question their wisdom?

Obviously, the dot-com collapse and the mortgage meltdown went a long way toward validating my approach to investing success. Meanwhile, exchange-traded funds went from a pocketful of possibilities to nearly 1500 choices. Are all of the ETFs in existence good for investors? Heck no! Yet the ability to protect against extreme downside losses is now part and parcel of the successful investing discussion.

Fast forward to recent commentary that I offered on Muni Bond ETFs. In it, I explained that fiscal cliff conversation about removing or curbing the tax-exempt status of munis had created a broad-based sell-off in the space. The explanation amounted to a factual observation. I also opined that it is possible that altering the tax-free nature of muni bond interest for the wealthy MIGHT reduce muni demand and cause higher borrowing costs for states/municipalities.

What I regarded as a relatively innocuous thought seemed to stir up a firestorm. E-mails and comments slamming my “partisan politics” poured in. Others defended my commentary as entirely apolitical; still others defended the expression of opinion itself.

Perhaps ironically, “Taxing the Wealthy and the Selling Of Muni Bond ETFs” had no political agenda nor partisan slant whatsoever. There may have been a joke or two, but even there, one could have misinterpreted the attempt at humor as “lefty liberalism” or “right wing conservatism.” In reality, I did not lean in any particular direction, but if I had, that would have been my prerogative. I am a money manager, writer and speaker… not a journalist.

So here’s a sequel to the previous article. The premise? MLPs are one of the worst-performing asset classes since the election for more than dividend tax rate uncertainty alone. Specifically, MLPs have favorable pass-through partnership structures where there are no corporate taxes. It follows that… in the course of looking for more tax revenue from the wealthy… asset classes with favorable limited tax/non-tax structures may be targeted in the same way that asset classes with favorable tax statuses are (Muni Bond ETFs). MLP structure uncertainty as well as dividend tax rate uncertainty are damaging returns.

MLP ETFs/ETNs Extreme Underachievement Since 11/6 Election
Yorkville High Income MLP (NYSEARCA:YMLP) -8.9%
UBS E-Tracs Alerian MLP Infrastructure (NYSEARCA:MLPI) -6.1%
JP Morgan Alerian MLP (NYSEARCA:AMJ) -6.0%
S&P 500 SPDR Trust (NYSEARCA:SPY) 0.1%
Vanguard Dividend High Yield (NYSEARCA:VYM) -0.1%

The wealthiest among us may have taken enormous risks to get to where they are today. On the other hand, most are far more cognizant of the importance of investing in less risky propositions in order to keep the wealth they have attained. While there is a fair degree of comfort in the income stream of dividend aristocrats and other corporations that consistently raise their dividend yield each year, those corporations are not required to pay out a certain percentage of their profits; MLPs distribute the income. More specifically, 90% of a MLP’s income must be derived from specific activities in order to maintain the favorable income tax exempt structure as a pass-through partnership.

Understandably, the wealthy may be drawn to MLPs as a means of ensuring an income stream. Moreover, there are few competitors that can enter the pipeline space, other than those companies already participating.

By the same token, the U.S. government is well aware that MLPs are particularly attractive to wealthier investors. And in a political environment where revenue generation looms particularly large, government leaders may look to tax wealthier individuals more on their MLP income; they might even propose a change to the MLP structure itself… the very same way that Canadian Royalty Income Trusts (”CANROYS”) found themselves filing for new tax designations.

In sum, with so many chips on the proverbial table, MLP investors may be selling first and asking questions later. And for the time being at least, MLP ETFs are one of the few asset classes that are struggling below a long-term, 200-day trendline.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.