By Neena Mishra
MLPs represent an attractive investment option for income-focused investors in the current rock-bottom interest rate environment. In addition to high yields, MLPs have relatively stable cash flows and solid growth potential. No wonder they have surged in popularity in recent years.
Why invest in MLPs?
Most MLPs are in involved in processing and transportation of energy commodities such as natural gas, crude oil, and refined products, under long term contracts.
As such they have relatively consistent and predictable cash flows, unlike exploration and production (E&P) companies, whose profits are highly correlated with commodity prices.
As MLPs are structured as pass-through entities—they do not pay taxes at the entity level and are thus are able to pay out most of their earnings to investors. (Read: 3 Excellent ETFs for Income Investors)
Further, MLPs have low correlations with many other asset classes including equities and commodities and thus add diversification benefits to the portfolios.
As the energy industry continues to evolve and grow with revolutionary developments in the field of unconventional energy, MLPs represent a great way to benefit from the growth.
MLPs come with complicated tax issues and many investors avoid investing in them only due to daunting tax requirements. MLPs issue complicated K-1s and further, since the pipelines run through several states, the investors may be required to file tax returns for all those states, in some cases.
Thankfully for the investors, some of the tax complexities can be avoided by owning them in ETP form. The payouts by the ETPs are reported as ordinary income on Form 1099, and therefore the K-1 forms are not required. (Read: Retire Early with these Dividend ETFs)
MLP ETFs or ETNs?
Funds that have more than 25% of their assets invested in MLPs are treated as C corporations for tax purposes. Further, the assets are required to be marked to market and a deferred tax liability for the unrealized gains needs to be recorded.
As a result, MLP ETFs have significant tracking errors. Most popular MLP ETF, Alerian MLP ETF (NYSEARCA:AMLP), has returned 22.34% since inception, while the underlying index returned 38.37% as of December 31, 2012.
As a result of the adverse tax issues, AMLP’s expense ratio before deferred taxes is 0.85%, but gross expense ratio is extremely high at 4.86%.
Despite its underperformance relative to the index, investors have continued to pour money into the fund, which has accumulated more than $5.7 billion in AUM so far. One advantage of investing in AMLP is that it is less volatile compared with MLP ETNs. Lower volatility results from its ability to reverse some of deferred tax liabilities when the market is down.
ETNs typically eliminate some of these complex tax consequences, as they do actually not hold any securities. However the investors should remember than ETNs are unsecured debt instruments and carry credit risk. (Read: ETF Investors--Beware The Coming ETN Backlash)
Annualized Std. Dev. (%)*
Annualized Returns (%)**
12- month Yield (%)
*Based on monthly returns using 2 years’ price data
**Based on average monthly returns using 2 years’ price data
Below we have highlighted three popular MLP ETNs.
JPMorgan Alerian MLP Index ETN (NYSEARCA:AMJ)
AMJ is the most popular ETN in the MLP space with about $5.7 billion in assets under management and daily volume over 1.2 million shares.
Launched in April 2009, this ETN is based on the Alerian MLP Index, which tracks the performance of 50 largest companies in the energy MLP sector.
The note charges investors 85 basis points a year in fees for its services and pays out an attractive yield of 4.6% currently.
Investors should note that the ETNs are subject to maximum issuance limit and this ETN stopped issuing new notes in June 2012. Investors who buy this ETF at a premium to its NAV incur the risk of loss in case they sell when the premium is no longer present. However, as of now, the ETN is trading close to its NAV.
UBS ETRACS Alerian MLP Infrastructure ETN (NYSEARCA:MLPI)
MLPI focuses on the infrastructure space within the MLP world. The note tracks the Alerian MLP Infrastructure Index, which is comprised of 25 energy infrastructure MLPs.
The product has attracted $748 million in AUM and trades in volumes approaching 65,000 shares a day.
This note also charges 85 basis points a year for expenses and pays out a yield of 4.40%.
Credit Suisse Cushing 30 MLP Index ETN (NYSEARCA:MLPN)
MLPN tracks the Cushing 30 MLP Index, which holds MLPs owning mid-stream energy infrastructure assets in North America. It is an equal weighted index, rebalanced on a quarterly basis. The ETN was launched in April 2010.
The note has so far attracted $391.2 million in assets. This note also charges 85 basis points a year for expenses and pays out a yield of 4.74% currently.
JPM-ALERN MLP (AMJ): ETF Research Reports (email registration required)
ALERIAN-MLP (AMLP): ETF Research Reports (email registration required)
E-TRC UBS ALERN (MLPI): ETF Research Reports (email registration required)
CS-CUSHING 30 (MLPN): ETF Research Reports (email registration required)