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ETF Specialist

Why MLP ETFs Require Careful Consideration

Wrapping partnerships up in a fund diminishes the tax benefits.

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A small but fervent base of income-oriented investors loves publicly traded master limited partnerships. To capitalize on the growing interest in the product class, a couple fund providers, ALPS and Van Eck, have decided to introduce exchange-traded funds consisting solely of MLPs. In some regards, throwing MLPs into a fund provides benefits: Company-specific risks are minimized through sector diversification, the process of tax filing is considerably easier, and one does not have to worry about a tax deferred account suddenly becoming taxable (details are provided below in linked articles). However, the trade-offs include lower investor returns due to double-taxation and the potential for considerable tracking error from the benchmark. While none of these factors makes MLP ETFs a bad investment choice, potential investors should choose carefully if they want to own MLPs in their portfolios.

Master limited partnerships, particularly those specializing in transporting and storing energy commodities, have been phenomenally strong performers by the standards of income investors--or any standards, for that matter. Not only do virtually all MLPs provide current yields substantially higher than the market in general, or even long-term Treasuries, but the best-run partnerships have been able to increase their unitholder distributions faster than any comparable class of high-income securities.

Paul Justice does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.