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ETF Specialist

AMLP: An ETF Cautionary Tale

Despite huge inflows this year, this MLP fund has some serious drawbacks.

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 ALPS Alerian MLP ETF (AMLP) has seen more than $2.5 billion of inflow in the past year. Investors are clearly clamoring for this fund, which invests in master limited partnerships, or MLPs. There are lots of reasons to like MLPs: They are a tax-advantaged, consistent source of income in a yield-starved market environment. The intention behind the fund is excellent: simplify the often complicated process of owning MLPs by applying an ETF wrapper to the broad asset class. However, AMLP is not the right vehicle for the majority of investors, and it represents one of the rare cases when buying the ETF structure makes very little sense.

Legally MLPs can make up only 25% of a portfolio registered under the Investment Company Act of 1940. Most mutual funds and ETFs are structured this way. To get around this issue, AMLP is actually structured as a corporation that pays income tax: Before return is passed on to the investor, it must be taxed at the corporate level. Although AMLP's prospectus expense ratio is 0.85%, its gross expense ratio (which accounts for these tax liabilities) is almost 5% as of September. As a result, AMLP has lagged its index significantly. Over the past year AMLP lagged by 10%, and since inception it trailed by a shocking 40%. The upside? When MLPs are down, AMLP declines less because it can reverse some of the deferred tax liabilities it has accrued. For all but the most risk-averse yet desperate-for-yield investors, this downside protection is not enough to make up for the fund's structural issues.

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Abby Woodham does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.