Midstream investing is well known for offering generous income, but surprisingly, that’s not the primary reason advisors are allocating funds to it.
Trumping income generation and energy exposure, total return is the primary way most advisors are using energy infrastructure in portfolios, according to “Energy Infrastructure 2022 Outlook: Inflation and Income Opportunities.” (Date: January 12, 2022. Sample size: 417 respondents, 36.2% RIAs.)
Since there are many midstream ETFs available to investors, each with its nuances, it’s important to consider what an investor wants midstream to do for their portfolio when deciding where to allocate funds.
For investors looking to maximize total return, RIC-compliant MLP ETFs might be the best fit, according to Stacey Morris, CFA, director of research at Alerian.
Regulated Investment Companies (RICs) are pass-through structures, acting as a conduit of income and gains to the end investor. To maintain their pass-through status, RICs cannot have more than 25% of their assets in MLPs. A fund that owns more than 25% MLPs will not be treated as a pass-through but rather will be taxed as a corporation, according to Morris.
Energy infrastructure ETFs are either structured as RICs with MLP exposure capped at 25% (also referred to as RIC-compliant) or as corporations with predominantly MLP exposure. Importantly, both types of ETFs provide a Form 1099 for tax reporting.
“Investors primarily looking for total return would likely be most interested in a RIC-compliant ETF,” Morris writes. “The potential for total return is arguably better for RIC-compliant MLP ETFs, because there is no tax drag in periods of strong performance like there would be for C-Corp MLP ETFs.”
That said, positive developments in the MLP space in recent years, including significant free cash flow generation and the proliferation of buyback programs, have improved the potential for total return from MLP-focused funds, Morris adds.
Another benefit of investing in RIC-compliant MLP ETFs is the greater diversification they bring to a portfolio.
According to Morris, MLP consolidations by parents, take-private deals, and other M&A activities have reduced the number of investable MLPs, so investors that want broad exposure to energy infrastructure companies will prefer a RIC-compliant product with MLPs and corporations.
There are currently seven RIC-compliant energy infrastructure ETFs, including the Alerian Energy Infrastructure ETF (ENFR), which tracks the Alerian Midstream Energy Select Index (AMEI).
For more news, information, and strategy, visit the Energy Infrastructure Channel.