The attractive yields and the expanding U.S. energy industry have made master limited partnership exchange traded funds a popular investment opportunity. Investors also like their diversification and non correlation with other major asset classes like stocks. Nevertheless, investors should not blindly jump in before weighing the potential risks.
The largest MLP ETF, the ALPS Alerian MLP ETF (AMLP), has gathered $574.6 million in assets under management since the start of the year, according to IndexUniverse, and gained 9.2% year-to-date. AMLP comes with a very attractive 5.94% 12-month yield.
In comparison, the S&P 500 increased 8.4% year-to-date and has a 2.03% yield.
The fund's top holdings include Enterprise Products Parnters (EPD), Kinder Morgan Energy Partners (KMP), Plains All American Pipeline (PAA), Magellan Midstream Partners (MMP) and Energy Transfer Partners (ETP). ETFs offer a great way to hold a diversified basket of MLPs.
"I looked at various products and ways to get exposure to the asset class: open-end funds, closed-end funds, exchange-traded funds, exchange-traded notes, the Alerian index," Chris Eades of ClearBridge Investmenst said in a Barron's article. "What is amazing is that over the past two years, the range in total return is 5% to 37%. That is remarkable for an asset class that most investors think is rather homogenous. That can be due to the leverage used by many funds."
MLPs build, acquire and operate transportation assets. While investors link MLPs with energy, specifically natural gas and crude oil, they are more involved with transporting the commodities. Consequently, the performance of MLPs is less dependent on commodity prices than on how much of the commodity is pushed through.
Many investors have gravitated to ETFs tracking the asset class for diversification and yield in a low-rate market.
The investments offer high yields because of their partnership structure, which does not require tax on the entity level, leaving the companies more money to distribute to shareholders.
However, MLP funds are structured as regular C-Corporations. Consequently, the ETFs pay corporate taxes on profits to meet their tax liability, which weighs on MLP ETFs' performance.
Morningstar last year was out with a warning on AMLP. Morningstar's caution flag is related to a complicated tax issue associated with MLPs.
Alps Alerian MLP ETF
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own AMLP.