If you’re seeking high yields, you may want to look into Master Limited Parternships (MLPs) exchange traded funds (ETFs) as a way to gain exposure to the energy market and cash in on some decent yields in the process.

MLPs usually hold infrastructure like pipelines that transport natural gas and crude oil, and a firm needs to generate at least 90% of its income from “qualifying” sources, such as the transport or processing of certain energy commodities, to be categorized as an MLP, writes iStockAnalyst. MLPs will make quarterly distributions, which makes them a stable and predictable source of cash, and since MLPs are partnerships, they come with additional tax perks. [MLP ETFs: A Fixed-Income Alternative.]

Alerian MLP ETF  (NYSEArca: AMLP) is the only MLP product available that is structured as a true ETF. However, investors have noted that the MLP ETF’s performance has lagged behind the performance of a similar exchange traded note (ETN), the UBS E-TRACS Alerian Natural Gas MLP ETN (NYSEArca: MLPG). The difference can be summed up by the tax characteristics of the two securities.

  • MLP ETNs‘ distributions are taxed at the individual income rate, whereas 80% of the MLP ETF’s distributions are taxed as a return of capital and 20% will be taxed as corporate income taxes. In addition, the difference between after-corporate tax distribution and the investor level cost basis reduction will be taxed at the qualified dividend rate of 15%.
  • The ETF structure is more favorable when it comes to distributions while the ETN is more efficient when it comes to returns generate through capital appreciation. Investors may also defer taxes for an extended period for the MLP ETF. Generally, the MLP ETN will have higher volatility on both the upside and downside as compared to the MLP ETF since the ETF will accrue a deferred tax liability/asset.

MLP funds like the JPMorgan Alerian MLP Index ETN (NYSEArca: AMJ) are a great alternative to futures-based natural gas ETFs, writes Don Dion for The Street. It should be noted that the top three holdings in AMJ account for nearly a third of the fund’s portfolio. Despite the slow gains in natural gas, the fund has been able contend with broad market performances.

Note that the threat of rising interest rates, illiquidity and volatility caused by ventures into riskier new industries all pose significant risk to the MLP market.

For more information on MLPs, visit our MLPs category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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