Master Limited Partnerships (MLPs) have increasingly captured the attention of investors, thanks to their attractive yields and solid performance over the last few years.
During VettaFi’s recent Alternatives Symposium, Stacey Morris, VettaFi’s head of energy research, shed light on MLPs, their potential benefits for portfolios, and how investors can gain exposure without the potential headaches of a Schedule K-1.
By the simplest definition, MLPs are pipeline companies that benefit from a unique tax structure. These publicly traded partnerships, which trade on major exchanges, are exempt from federal taxes at the entity level. To achieve for this special status, at least 90% of their income must be derived from “qualifying sources.” Those sources include the production, storage, transportation, or processing of minerals and natural resources.
MLPs are attractive to investors because they offer tax-deferred distributions and typically provide a high yield. Often, investors use them in income portfolios, as alternative investments, or for real asset exposure in an investment strategy.
How MLPs Fit Into Portfolios
MLPs can serve several purposes within an investment portfolio.
Income generation: MLPs are primarily used in income portfolios due to their high yields, with the Alerian MLP Infrastructure Index (AMZI) yielding 7.3% as of July 30. MLP yields don’t fluctuate with interest rates, and MLPs typically have low correlations with other income investments like utilities and bonds, according to Morris.
Liquid alternatives: Due to their distinct tax treatment and exclusion from broad market indexes, MLPs can also be considered an alternative investment.
Real asset exposure: Investing in MLPs provides exposure to physical infrastructure assets, particularly pipelines and other energy infrastructure. A significant advantage is that many MLP contracts include inflation adjustments, offering a hedge against rising costs. MLPs tend to perform well during times of elevated inflation.
Energy allocation: MLPs can be used as a defensive energy sector investment with less direct commodity exposure compared to oil and gas producers.
Accessing MLPs
Direct investment in MLPs involves navigating the complexities of Schedule K-1 tax forms. However, investors can avoid this hassle through various investment products. ETFs, ETNs, and mutual funds can provide MLP exposure and issue a standard 1099 tax form.
Two ETFs that offer access to MLPs are the Alerian MLP ETF (AMLP ) and the Alerian Energy Infrastructure ETF (ENFR ). AMLP provides access to the Alerian MLP Infrastructure Index (AMZI) while ENFR is based on the Alerian Midstream Energy Select Index (AMEI). AMEI caps MLPs at 25%, and the balance of the index is U.S. and Canadian energy infrastructure corporations.
AMLP’s underlying index is a capped, float-adjusted, capitalization-weighted composite of energy infrastructure MLPs. Notably, AMLP is the largest MLP ETF as well as the second largest energy ETF.
ENFR is a composite of North American midstream energy infrastructure companies. The fund is the lowest-cost ETF in the midstream category.
Investors may also consider gaining MLP exposure through exchange-traded notes (ETN). ETNs are unsecured debt obligations of an issuing bank, which agrees to pay the investor a specified return typically based on an index. The largest MLP ETN is the JPMorgan Chase Alerian MLP Index ETN (AMJB ).
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VettaFi LLC (“VettaFi”) is the index provider for AMLP, ENFR and AMJB, for which it receives an index licensing fee. However, AMLP, ENFR, and AMJB are not issued, sponsored, endorsed or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing or trading of AMLP, ENFR, and AMJB.
