MLP ETFs that hold more than 25% of their portfolio in MLPs are structured as C-Corporations in order to track an underlying MLP-related index. Due to the C-Corporation structure, they must pay corporate income tax on distributions before passing them to investors. Consequently, MLP ETFs may incur higher fees that would cut into overall performance, leading to an underperformance compared to the underlying benchmark. [MLP ETFs Try to Address Tax Headaches]
The MLP exchange traded notes, like the UBS ETRACS Alerian MLP Infrastructure ETN (NYSEArca: MLPI), have outperformed MLP-related ETFs, such as the Alerian MP ETF (NYSEArca: AMLP). 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. 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. For instance, First Trust introduced the actively managed First Trust North American Energy Infrastructure Fund (NYSEArca: EMLP), the first RIC-compliant MLP product, limits MLP holdings to 25% and includes other energy infrastructure firms with similar characteristics to MLPs. Additionally, the newer Global X MLP & Energy Infrastructure ETF (NYSEArca: MLPX) and he Alerian Energy Infrastructure ETF (NYSEArca: ENFR) to also limit holdings of MLPs [How MLP ETF Structures Affect Yields and Returns]
For more information on master limited partnerships, visit our MLPs category.
Max Chen contributed to this article.