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While broad energy ETFs have largely seen outflows over the last two years, midstream or energy infrastructure ETFs have enjoyed solid inflows. Often, these will be categorized as MLP ETFs. It is a simple delineation among the more than 4,000 ETFs. However, most “MLP ETFs” only own up to 25% MLPs.
For investors allocating to energy infrastructure, it is important to understand that there are two types of MLP funds with notable differences. This note explains MLP funds, their use cases, and other ways investors can access the midstream space. Investors are encouraged to review prospectuses and fund materials for more detail.
Investors may prefer to access MLPs through funds to avoid the Schedule K-1 that comes with direct MLP investment. There are two types of MLP funds, whether looking at ETFs, mutual funds, or closed-end funds. Both types issue Forms 1099 but have other important differences in tax treatment. Specifically, any fund with more than a 25% weighting to MLPs is taxed as a corporation.
On the other hand, funds that own up to 25% MLPs are structured as RICs. Most funds registered under the Investment Company Act of 1940 (often called ’40 Act Funds) are RICs. RICs are considered pass-through entities and aren’t subject to corporate taxes.
Among midstream investment funds, there is a small subset that predominantly own MLPs and are taxed as corporations. The number of these MLP-focused funds has declined over the last several years (read more). There are only three MLP-focused ETFs structured as corporations. The largest of these is the Alerian MLP ETF (AMLP). AMLP is the second-largest energy ETF.
MLP-focused funds tend to appeal to investors who are looking to maximize income. Historically, MLP funds structured as corporations have retained the tax characteristics of MLP distributions, including the potential for tax-deferred return of capital (read more). For longtime holders, the tax treatment of distributions from MLP funds is typically return of capital or qualified dividends, but investors should consult fund documents.
MLPs typically offer higher yields than midstream corporations. The Alerian MLP Infrastructure Index (AMZI) was yielding 6.8% as of March 27. AMZI is the underlying index for AMLP.
Due to their taxation as C-Corps, MLP-focused funds can experience tax drag, and fund performance would be reduced by the taxes accrued. There can also be times when the fund’s tax drag is negligible due to past losses.
An MLP fund, taxed as a corporation via its partnership holdings in the underlying MLPs, will accrue deferred income taxes for any accelerated deprecation taken by the MLPs and for the unrealized net gain on its underlying holdings. Deferred income taxes are based on the corporate tax rate (currently 21%), plus a few percentage points for state taxes.
For example, if an index of MLPs gains 10%, the ETF tracking that index may only gain 7.7% if it is accruing for a deferred tax liability (DTL). On the other hand, a DTL can act as a buffer if equities are falling. In that scenario, a 10% decline in the underlying MLP index would equate to only a 7.7% decline in the fund as the DTL shrinks (similar to adding an asset). This simplified example is depicted below.
There can be times when tax drag for MLP-focused funds is minimal due to past losses from holdings declining in value. In simple terms, past capital losses can offset capital gains. Fund-level taxation adds complexity, but the attraction of MLP-focused funds has historically been their generous yields.
Most midstream funds, including ETFs, are structured as RICs and only own up to 25% MLPs. There are around a dozen midstream RIC ETFs, encompassing active and passive approaches. Alongside MLPs, these RIC ETFs will typically own U.S. and Canadian midstream corporations. Some funds have sizable allocations to utilities, which tend to have lower yields and greater interest rate sensitivity relative to midstream. Because MLPs are only up to 25% of RIC-compliant “MLP ETFs” by weighting, it is important that investors understand what is in the other 75% of the portfolio.
An investor may prefer to get midstream/MLP exposure through a RIC if they are primarily seeking total return. RICs do not have the potential tax drag associated with MLP-focused funds taxed as corporations but also have lower yields. The Alerian Midstream Energy Select Index (AMEI), which caps MLPs at 25% and also includes U.S. and Canadian midstream corporations, was yielding 5.1% as of March 27. AMEI underlies the Alerian Energy Infrastructure ETF (ENFR). The 10-year average yield difference between AMZI and AMEI is ~200 basis points.
Investors may also prefer RIC products if they desire greater diversification. RICs must adhere to diversification rules, while MLP funds structured as corporations are considered nondiversified. Funds with corporations and MLPs provide broader exposure to the midstream universe.
Investors may also want to own familiar corporations like Kinder Morgan (KMI) or Williams (WMB) that no longer have related MLPs. Additionally, funds with U.S. midstream corporations tend to have more exposure to natural gas infrastructure, which has benefited from a strengthening outlook for North American natural gas demand (read more).
Often, listings of MLP ETFs will also include exchange-traded notes (ETNs). There are currently five energy infrastructure ETNs. The largest is the JPMorgan Alerian MLP Index ETN (AMJB). The main appeal of ETNs is little or no tracking error. Midstream ETNs also issue Forms 1099. ETNs tend to be most suitable for investing in tax-advantaged accounts, because their coupons are taxed at ordinary income rates. When using ETNs, investors should be comfortable with the credit risk of the issuing bank (read more).
For international investors, there are two UCITS ETFs that provide exposure to North American energy infrastructure. For context, UCITS is a European regulatory framework intended to protect investors. The Alerian Midstream Energy Dividend UCITS ETF (MMLP LN) tracks an Alerian index that includes U.S. and Canadian midstream corporations with an allocated exposure to MLPs through AMJB.
Midstream investors primarily seeking income will likely prefer a fund that predominantly owns MLPs. Investors who are more focused on total return and broad midstream exposure will likely prefer a RIC-compliant midstream ETF.
Vettafi.com is owned by VettaFi LLC (“VettaFi”). VettaFi is the index provider for AMLP, MLPB, ENFR, ALEFX, and MMLP.LN, for which it receives an index licensing fee. However, AMLP, MLPB, ENFR, ALEFX, and MMLP.LN 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, MLPB, ENFR, ALEFX, and MMLP.LN.
This article was originally published April 1st, 2025 on ETF Trends.
While broad energy ETFs have largely seen outflows over the last two years, midstream or energy infrastructure ETFs have enjoyed solid inflows. Often, these will be categorized as MLP ETFs. It is a simple delineation among the more than 4,000 ETFs. However, most “MLP ETFs” only own up to 25% MLPs.
For investors allocating to energy infrastructure, it is important to understand that there are two types of MLP funds with notable differences. This note explains MLP funds, their use cases, and other ways investors can access the midstream space. Investors are encouraged to review prospectuses and fund materials for more detail.
Investors may prefer to access MLPs through funds to avoid the Schedule K-1 that comes with direct MLP investment. There are two types of MLP funds, whether looking at ETFs, mutual funds, or closed-end funds. Both types issue Forms 1099 but have other important differences in tax treatment. Specifically, any fund with more than a 25% weighting to MLPs is taxed as a corporation.
On the other hand, funds that own up to 25% MLPs are structured as RICs. Most funds registered under the Investment Company Act of 1940 (often called ’40 Act Funds) are RICs. RICs are considered pass-through entities and aren’t subject to corporate taxes.
Among midstream investment funds, there is a small subset that predominantly own MLPs and are taxed as corporations. The number of these MLP-focused funds has declined over the last several years (read more). There are only three MLP-focused ETFs structured as corporations. The largest of these is the Alerian MLP ETF (AMLP). AMLP is the second-largest energy ETF.
MLP-focused funds tend to appeal to investors who are looking to maximize income. Historically, MLP funds structured as corporations have retained the tax characteristics of MLP distributions, including the potential for tax-deferred return of capital (read more). For longtime holders, the tax treatment of distributions from MLP funds is typically return of capital or qualified dividends, but investors should consult fund documents.
MLPs typically offer higher yields than midstream corporations. The Alerian MLP Infrastructure Index (AMZI) was yielding 6.8% as of March 27. AMZI is the underlying index for AMLP.
Due to their taxation as C-Corps, MLP-focused funds can experience tax drag, and fund performance would be reduced by the taxes accrued. There can also be times when the fund’s tax drag is negligible due to past losses.
An MLP fund, taxed as a corporation via its partnership holdings in the underlying MLPs, will accrue deferred income taxes for any accelerated deprecation taken by the MLPs and for the unrealized net gain on its underlying holdings. Deferred income taxes are based on the corporate tax rate (currently 21%), plus a few percentage points for state taxes.
For example, if an index of MLPs gains 10%, the ETF tracking that index may only gain 7.7% if it is accruing for a deferred tax liability (DTL). On the other hand, a DTL can act as a buffer if equities are falling. In that scenario, a 10% decline in the underlying MLP index would equate to only a 7.7% decline in the fund as the DTL shrinks (similar to adding an asset). This simplified example is depicted below.
There can be times when tax drag for MLP-focused funds is minimal due to past losses from holdings declining in value. In simple terms, past capital losses can offset capital gains. Fund-level taxation adds complexity, but the attraction of MLP-focused funds has historically been their generous yields.
Most midstream funds, including ETFs, are structured as RICs and only own up to 25% MLPs. There are around a dozen midstream RIC ETFs, encompassing active and passive approaches. Alongside MLPs, these RIC ETFs will typically own U.S. and Canadian midstream corporations. Some funds have sizable allocations to utilities, which tend to have lower yields and greater interest rate sensitivity relative to midstream. Because MLPs are only up to 25% of RIC-compliant “MLP ETFs” by weighting, it is important that investors understand what is in the other 75% of the portfolio.
An investor may prefer to get midstream/MLP exposure through a RIC if they are primarily seeking total return. RICs do not have the potential tax drag associated with MLP-focused funds taxed as corporations but also have lower yields. The Alerian Midstream Energy Select Index (AMEI), which caps MLPs at 25% and also includes U.S. and Canadian midstream corporations, was yielding 5.1% as of March 27. AMEI underlies the Alerian Energy Infrastructure ETF (ENFR). The 10-year average yield difference between AMZI and AMEI is ~200 basis points.
Investors may also prefer RIC products if they desire greater diversification. RICs must adhere to diversification rules, while MLP funds structured as corporations are considered nondiversified. Funds with corporations and MLPs provide broader exposure to the midstream universe.
Investors may also want to own familiar corporations like Kinder Morgan (KMI) or Williams (WMB) that no longer have related MLPs. Additionally, funds with U.S. midstream corporations tend to have more exposure to natural gas infrastructure, which has benefited from a strengthening outlook for North American natural gas demand (read more).
Often, listings of MLP ETFs will also include exchange-traded notes (ETNs). There are currently five energy infrastructure ETNs. The largest is the JPMorgan Alerian MLP Index ETN (AMJB). The main appeal of ETNs is little or no tracking error. Midstream ETNs also issue Forms 1099. ETNs tend to be most suitable for investing in tax-advantaged accounts, because their coupons are taxed at ordinary income rates. When using ETNs, investors should be comfortable with the credit risk of the issuing bank (read more).
For international investors, there are two UCITS ETFs that provide exposure to North American energy infrastructure. For context, UCITS is a European regulatory framework intended to protect investors. The Alerian Midstream Energy Dividend UCITS ETF (MMLP LN) tracks an Alerian index that includes U.S. and Canadian midstream corporations with an allocated exposure to MLPs through AMJB.
Midstream investors primarily seeking income will likely prefer a fund that predominantly owns MLPs. Investors who are more focused on total return and broad midstream exposure will likely prefer a RIC-compliant midstream ETF.
Vettafi.com is owned by VettaFi LLC (“VettaFi”). VettaFi is the index provider for AMLP, MLPB, ENFR, ALEFX, and MMLP.LN, for which it receives an index licensing fee. However, AMLP, MLPB, ENFR, ALEFX, and MMLP.LN 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, MLPB, ENFR, ALEFX, and MMLP.LN.
This article was originally published April 1st, 2025 on ETF Trends.
