MLP ETFs: A Fixed-Income Alternative

Are you looking for a stable and relatively high yield fixed-income asset? Then you may want to take a gander at master limited partnerships (MLPs) exchange traded funds (ETFs), which have only recently come to market.

If you’re unfamiliar with this sector, here’s the short of it: MLPs are a great way to play the energy industry with the added benefit of regular dividend payouts and investment appreciation.
Wells Fargo Senior Energy MLP Analyst Michael Blum believes that MLPs still have plenty of potential, with strong business fundamentals, distribution growth and attractive yields, writes Brian Sylvestor for Investor Ideas.

Those are the basics. Now here’s what you really need to know about this sector that’s more than likely new to you:

• There are different kinds of MLPs. Exploration and production (E&P) MLPs plays produce oil and natural while gather and processing (G&P) MLPs deal in extracted natural gas liquids (NGLs). G&P MLPs benefit from rising oil prices and low natural gas prices.
• Around 80% of distributions received from MLPs will be tax deferred until the asset is sold. MLPs are also equities, which means there is an upside in the price. Additionally, MLP distributions may change. Blum forecasts a 5% medium distribution growth for the MLP sector over the next couple of years.
• MLPs are slightly sensitive to interest rate changes – a spike in interest rates will cause MLPs to underperform, so watch for any hints of Federal Reserve action on that front. MLPs are also correlated to commodity prices, with a higher correlation toward rising crude oil – certainly an advantageous situation these days.
• Short-term bursts won’t affect MLPs too much because they operate based on volume of oil or natural gas shipped, which provide investors with predictable and stable cash flows, reports Jim Fink for Investing Daily.
• MLPs pay taxes at the partner, or unitholder, level and most of their income flow to their partners in the business, says Christine Benz for Morningstar. By gaining this tax status, MLPs must provide 90% of their income from “qualified sources,” or producing, processing, and transporting energy.
• Since MLP payouts aren’t dividends, investors report income on a K-1 form, as you would with futures-based ETFs.

Now, let’s get into a few of the ETFs and exchange traded notes (ETNs):

• Alerian MLP ETF  (NYSEArca: AMLP): AMLP launched last September, and it’s the first MLP ETF. Until this fund came along, MLP access could only be had in ETNs. It delivers a nice yield (currently close to 6%), though its performance has been flat since launch. This fund is diversified across three primary MLPs: petroleum transportation, natural gas pipelines and gathering and processing.
• Credit Suisse Cushing 30 MLP Index (NYSEArca: MLPN): MLPN owns 30 companies involved in the energy infrastructure market. Each holding in the fund starts off with a 3.33% weighting after rebalancing quarterly, making it a more equally-weighted fund instead of the more common route of cap-weighting.
• UBS E-TRACS Alerian Natural Gas MLP ETN (NYSEArca: MLPG): MLPG also appeared on the market in March 2010. It has a current yield of 6.23%. Its top 10 components range between 9.7% of the total portfolio (in the case of Enterprise Products Partners) down to 4.4% (in the case of MarkWest Energy Partners).
• JPMorgan Alerian MLP Index ETN (NYSEArca: AMJ): AMJ has a current yield of 5.04%. It’s a tad more concentrated than other MLP funds, however; the top two constituents account for more than 25% of the fund. If concentration is a concern for you, then you might be better off with an equally-weighted fund, or one that simply has its holdings spread out a little more.

Disclosure I am Long AMJ shares.