Master limited partnerships and the corresponding exchange traded funds have been favored destinations for income investors in recent years, so much so that in 2014, assets held by MLP exchange traded products jumped to over $22 billion, more than double the amount those products held three years earlier.
The actively managed First Trust North American Energy Infrastructure Fund (NYSEArca: EMLP) is one of the key drivers of MLP ETF growth. Last year’s top-performing energy sector ETF, EMLP has gained fans in part because it caps its exposure to MLPs, which allows the fund to deliver more conventional ETF tax treatment than those MLP funds with C-corporation structures.
Hybrid MLP ETFs, or non-C-corporation MLP ETFs, have reduced direct MLP holdings to under 25% to meet regulatory rules and hold other energy infrastructure stock through subsidiaries as a way to avoid double taxation. [MLP ETF Education]
“An unusual attribute of “pure-play” MLP ETFs (which invest solely in MLPs) is that, unlike the vast majority of ETFs, these funds are subject to an additional layer of corporate income taxes. Ironically, this effectively cancels out one of the features of MLPs that investors find most attractive: namely, that MLP cash flows typically flow through to investors without the MLP paying corporate income taxes. Assuming a 35% federal corporate income tax rate, a hypothetical 10% total return for the underlying holdings of a “pure play” MLP ETF would result in a roughly 6.5% return for fund investors (before fund expenses since the fund itself will have an expense for income taxes). This additional layer of taxation is avoided by ETFs that limit MLP allocations to 25%, including EMLP,” said First Trust ETF Strategist Ryan Issakainen in a new research note.
As investors have become increasingly aware of MLP ETF tax issues in recent years, EMLP has gained a broader following. The ETF, which debuted in June 2012, recently topped $1 billion in assets under management.
For the week ending Jan. 25, EMLP’s shares outstanding total rose by 400,000 as the ETF added $47.5 million in new assets, according to AdvisorShares data. EMLP is now one of the largest actively managed ETFs in the U.S.
EMLP has also proven resilient as oil prices have plunged. Over the past 90 days, the ETF has gained 1% while the United States Oil Fund (NYSEArca: USO) has plunged 46%. EMLP has a 12-month distribution rate of almost 3.1%. [Active MLP ETF Works]
“2014 provided a good reminder of how difficult it is to accurately forecast crude oil prices. Like any commodity, prices are ultimatelydetermined by supply and demand; but, more so than most other commodities, free market forces are heavily influenced by both geopolitics and government regulations. As global oil markets seek equilibrium in the months ahead, we believe investors should be prepared for continued volatility. Moreover, ETF investors should evaluate the extent to which certain funds may be exposed to future volatility in the price of oil and natural gas. For those seeking exposure to non-cyclical energy infrastructure investments, we believe EMLP may be a valuable alternative to MLP index ETFs,” adds Issakainen.
First Trust North American Energy Infrastructure Fund
