The market environment has been very challenging for the income
investors. Traditional income assets currently produce miniscule
yields and some even fail to deliver above-inflation
returns. Search for higher yields sometimes lures investors to
Many high-yielding investments had positive returns during the
first-half of this year, as interest rates plunged despite Fed's
taper. That situation may change if interest rates start creeping
up, particularly in view of rising inflation worries. Further, most
of these assets now look expensive compared to their growth
Best ETF Strategies to consider now
MLPs represent an attractive investment option for income-focused
investors in the current environment. In addition to high
yields (~4% to 6% currently), MLPs have relatively stable cash
flows and solid growth potential. Further, research suggests that
there is no material correlation between interest rates and MLPs'
Energy production boom in the US remains the long-term growth
driver for MLPs. With their spectacular returns of 366% during the
last 10 years (Alerian MLP Index return), it is not surprising that
MLPs have surged in popularity in recent years. (Read:
3 Impressive Mid Cap ETFs to buy now
However MLPs are complicated structures and investors need to
understand them properly before investing.
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.
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 and Rising Rates
Like all high income products, MLPs also tend to react negatively
to rise in interest rates initially. But
shows there is no material correlation between 10-year
treasury rates and Alerian MLP index performance in the
Dividend Boom and Share Buybacks Put These ETFs in
One of the reasons is that many MLPs use fixed rate debt for
majority of their borrowings. Another reason could be that
investors hold MLPs for a long time due to tax consequences and
thus they do not have a significant adverse reaction to rising
interest rates unlike other rate sensitive assets like Utilities
At the same time, MLP asset class does not have a long history and
we have not seen materially rising interest rates since MLPs have
been in existence. However, since they have been around, we have
not seen any significant
with interest rates.
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.
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 (
) has returned 59.43% since inception, while the underlying index
returned 107.13% during the same period (as of June 30, 2014).
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 8.56% currently.
Despite its underperformance relative to the index, investors have
continued to pour money into the fund, which has accumulated more
than $9 billion in AUM so far. One advantage of investing in AMLP
is its lower volatility 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
|3 Year Standard Deviation
|3 Year Return
|12- month Yield
Below we have highlighted three popular MLP ETNs.
JPMorgan Alerian MLP Index ETN (
AMJ is the most popular ETN in the MLP space with about $6.6
billion in assets under management.
Launched in April 2009, this ETN is based on the Alerian MLP Index,
which tracks the performance of 50 largest companies in the energy
The note charges investors 85 basis points a year in fees for its
services and pays out an attractive yield of 4.43% currently.
The 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
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 $2.2 billion in AUM. This note also
charges 85 basis points a year for expenses and pays out a yield of
Credit Suisse Cushing 30 MLP Index ETN (
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 $946 million in assets. This note
also charges 85 basis points a year for expenses and pays out a
yield of 3.75% currently.
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JPM-ALERN MLP (AMJ): ETF Research Reports
ALERIAN-MLP (AMLP): ETF Research Reports
E-TRC UBS ALERN (MLPI): ETF Research Reports
CS-CUSHING 30 (MLPN): ETF Research Reports
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