Attracted to the yield opportunities, investors are loading up on master limited partnership exchange traded funds, but one should understand the structure of the investments, lest you hit an unwanted surprise.
MLP funds, which come with an average 5.2% yield, are a popular income-generating investment, attracting $9.6 billion in inflows this year through September, compared to $7 billion for all of 2012, reports Murray Coleman for the Wall Street Journal.
The UBS ETRACS Alerian MLP Infrastructure ETN (NYSEArca: MLPI) has gained an average annualized 15.6% in the last three years, on par with gains in the non-yield-oriented S&P 500 Index. However, the largest MLP-related ETF, Alerian MP ETF (NYSEArca: AMLP), has gained 10.1% annually in the past three years.
While both funds track the Alerian MLP index, the exchange traded note version has been outperforming. This can be attributed to the ETN structure. As an unsecured debt instrument that replicates the return of the MLP index, the ETN vehicle is not subject to the double-taxation effects associated with a C-Corporation.
The ETN does not technically own the underlying securities, so it avoids the corporate income taxes. On the other hand, MLP ETFs with 25% or more of its assets in MLPs are considered C-Corporations and will take the tax hit. [The 411 on MLP ETFs & ETNs]
ETNs, though, are subject to credit risk of the underwriting bank or issuer.
In an attempt to skirt the tax problems, newer MLP-related ETFs limit MLP holdings to 25% of the total portfolio. [MLP ETFs Try to Address Tax Headaches]