Yesterday hailed the launch of the first MLP ETF (Master Limited Partnerships) which have been crushing the S&P500 this year from a capital appreciation and yield standpoint. For the uninitiated, MLPs are publicly traded companies that are structured as partnerships such that they must distribute the majority of their profits, but in turn, they are shielded from certain tax liabilities that conventional corporations are not. The Alerian MLP ETF (AMLP) will hold positions meant to mimic the Alerian MLP Index which is up 12% YTD vs. a loss of 7% for the S&P500.
Previously, if you wanted to participate in MLP investing, you had to either invest in individual issues or invest in some of the various exchange traded notes (ETNs), which are subject to solvency risk of the issuing firm. Typically, investors are forced to deal with the dreaded K-1 form when investing in an MLP which can be a major hassle at tax time. Not only is it another form to complete, but from first-hand experience, I can confirm that the form is always the last to arrive, around mid-March or so, which holds up filing your taxes even if everything else is ready. This ETF will not require a K-1 and will obviously provide the benefit of diversification of multiple Master Limited Partnerships, spreading both company and sector risk.
MLP Yields and Risks
People generally buy Master Limited Partnership instruments for the high yield, often upwards of 6%. Given the extraordinarily high payouts, the common stock tends to be less volatile than other higher Beta sectors, and the payouts are often relatively steady over time (some pay monthly). Many have continued to pay out consistently even through the recent economic crash. Moving forward, while the economy is showing more signs of trouble than hope at this point, there’s little evidence that the MLPs, primarily in the energy sector are in dire straights. This is further evidenced by the underlying index outperformance.
The one thing to be mindful of is the potential for a bubble in MLPs. For the first time in years, there has been much press regarding the once-quiet segment, with the launch of various ETNs, and now this ETF generating buzz. Fortunately, many large institutions and pension funds cannot hold MLPs due to their structure which is already tax-advantaged (hence, can’t enjoy a double tax advantage), so perhaps no bubble has formed yet just from the retail investor side. But when your fellow cube dwellers start talking about MLPs just like they were talking about internet stocks in 1999 and gold in 2009, maybe it’s time to start thinking about taking some profits.
If you’re thinking about purchasing individual MLPs or ETNs for a self-directed IRA, you’ll want to consider the following MLP Tax Treatment and perhaps even seek professional tax advice for AMLP given this new breed of an ETF that doesn’t require an IRS K-1.
Disclosure: No position in any ETFs or ETNs referenced in this article.