Exchange traded funds that follow master limited partnerships, or MLPs, have been a popular draw for investors looking for attractive yields and an alternative energy sector play. Nevertheless, MLP ETFs come with their own quirks.
The Alerian MLP ETF (NYSEARCA:AMLP), which comes with a 5.71% 12-month yield, has gained 14.4% year-to-date. AMLP has amassed $6.2 billion in assets under management, ranking it among the largest energy sector funds, behind the Energy Select Sector SPDR ETF (NYSEARCA:XLE) with $7.6 billion.
The JPMorgan Alerian MLP Index ETN (NYSEARCA:AMJ), which has a 4.50% 12-month yield and $5.9 billion in assets, is up 23.4% year-to-date.
Due to the way the MLP funds are constructed, there is a noticeable performance discrepancy. Ned Davis Research's Neil Lesson points out that since MLP ETFs are structured as C-Corporations, the ETFs incur a deferred tax liability out of the returns every day, reports Brendan Conway for Barron's. Consequently, AMLP has a 0.85% expense ratio plus 4% fees listed as "other expenses."
"Because of legislation forbidding open-end funds from owning more than 25% of their portfolio in MLPs, AMLP is structured as a C-corporation," according to Morningstar analyst Abby Woodham. "Distributions from ETN competitors are taxed immediately, but the ETF structure passes the tax deferment benefits of MLPs to holders of AMLP."
On the other hand, the exchange traded note does not have to hold the securities it tracks and just mimics the performance of the underlying index.
"Owners of AMJ simply pay ordinary income tax rates on distributions and capital gains rates upon the sale of shares," Woodham said.
However, potential investors should be aware that AMJ's issuing bank, JPM organ, has stopped issuing new shares, which has resulted in trading premiums versus the index.
In an attempt to circumvent the C-Corporation liability within the ETF structure, First Trust created the First Trust North American Energy Infrastructure Fund (NYSEARCA:EMLP), an actively managed ETF that limits direct MLP exposure to less than 25% and holds exposure to MLP affiliates, Canadian income trusts and successor companies, pipeline companies, utilities and other energy infrastructure companies. EMLP has a 0.95% expense ratio and a 2.50% 30-day SEC yield. The fund is up 16.3% year-to-date.
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.
MLP fund investors will not be required to fill out K-1 forms. Instead, investors will receive a single 1099 form.
Max Chen contributed to this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.