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Since 2004, over 130 MLP/midstream investment products have been launched, including closed-end funds (CEFs), ETFs, exchange-traded funds (ETNs) and mutual funds. Investment products provide an important solution in the midstream/MLP space: they allow investors to obtain MLP exposure on a 1099 instead of a Schedule K-1. Many investment products are Numerous vehicles have been launched, but only a few are still available today. This report discusses the MLP product landscape and some of the notable changes in recent years that coincide with changes in the North American midstream industry.
ETFs: There are several times more RICs than C-Corp ETFs.
There are two main types of MLPs in the MLP space: funds that own MLPs and are taxed as C corporations, and funds that are structured as regulated investment companies (RICs). ETFs that focus on MLPs, which are typically taxed as corporations, are for investors looking to maximize after-tax yields, but RICs are for investors looking for total return (read more).
There are only three MLP ETFs that are subject to corporate income tax: two passive and one active. The Alerian MLP ETF (AMLLP) was the first MLP ETF and remains the largest energy infrastructure ETF.
RICs can only own a maximum of 25% in MLPs, with the remaining 75% of their portfolio typically allocated to U.S. and/or Canadian midstream, utilities, or other energy companies. There are about a dozen midstream-focused RIC ETFs, with a mix of active and passive approaches. Some new entrants in the space also employ option strategies.
ETN: A smaller menu, but still with plenty of variety
An ETN is an unsecured obligation of an issuer that agrees to pay out the returns of an index. The first MLP ETN was issued by Bear Stearns in 2007 based on the Alerian Index. After acquiring Bear Stearns, JP Morgan launched its own ETN, the JPMorgan Alerian MLP Index ETN (AMJ), in 2009. From 2010 to 2020, more than two dozen MLP ETNs, including leveraged notes, were issued by various banks. However, many of them have been redeemed over time. At least six MLP ETNs have been liquidated between 2020 and 2023.
AMJ is the largest MLP ETN and just matured on May 24, 2024. However, JPMorgan Chase Release A successor ETN, AMJB, also joined earlier this year. Alerian MLP Index (AMZ) matures in 2044. AMJB is currently the largest MLP ETN due to the large amount of assets moving from AMJ to AMJB. We estimate that there are eight actively traded midstream ETNs issued by JPMorgan, UBS and Barclays in total, and all but one are Alerian IndexFour are based on midstream indexes that include companies. Only one is a leveraged ETN. ETNs have little to no tracking error and are typically best suited for investing in tax-advantaged accounts (read more).
Closed-end funds: First in the game but declining in numbers
Closed-end funds were the first pooled investment products launched in 2004 to collect K-1s and provide investors with Forms 1099. Between 2004 and 2014, several MLP-focused CEFs were launched, as well as several RIC CEFs. CEFs may trade at a discount or premium to their net asset value and may have limited liquidity. Closed-end funds often use leverage.
Many of the MLP-focused CEFs that were taxed as corporations have either merged with other funds, converted to RICs or been liquidated. Merged Four CEFs merged into new actively managed ETF (read moreEarlier this month, shareholders approved Two CEFs, CEM and CTR, have announced that they have signed a memorandum of understanding (MOU) with the ClearBridge Energy Midstream Opportunity Fund (Emo). The merger will likely leave only three MLP-focused CEFs taxed as corporations and actively traded today. There are several other RIC-compliant midstream CEFs, most of which are issued by Tortoise. Tortoise launched the first MLP CEF (TYG) in 2004, but TYG is currently structured as a RIC.
Mutual funds: Active managers look beyond MLPs
There are many MLP- or midstream-focused mutual funds structured as corporations or RICs. Like ETFs and CEFs, mutual funds that own more than 25% of MLPs are taxed as corporations. Mutual funds tend to have higher fees than ETFs due to active management. Mutual funds taxed as corporations are more likely to own midstream C corporations, while two passive ETFs taxed as corporations have a narrow mandate to focus on MLPs based on an underlying index.
As consolidation reduces the number of energy infrastructure MLPs, mutual funds that can invest in the companies may have a wider pool of options and more ways to generate alpha from stock selection, which was perhaps easier when midstream companies outperformed MLPs in 2020 and 2021.read more). With MLPs outperforming C-Corps in 2022 and 2023, investing in C-Corps could cause a mutual fund to lag if benchmarked against an MLP index. Investors who pay higher fees for active management will expect to outperform their benchmark. Thus, the difference between MLP and C-Corp performance adds important context to a fund’s performance.
The investment environment evolves along with the midstream sector
The MLP product landscape has changed over time in tandem with the development of the midstream sector. Consolidation has reduced the number of publicly traded midstream MLPs. Midstream companies also now represent a larger percentage of the market by market capitalization. Against this backdrop, it is not surprising that more RIC ETFs have appeared on the market. Similarly, historically, MLP-focused investments such as CEFs and ETNs have declined in number over time. That said, there are several CEFs and ETNs that offer exposure to both MLPs and corporations. Two passive ETFs that are taxed as corporations maintain MLP-focused exposure. And mutual funds that are taxed as corporations generally have broader mandates that include both MLPs and corporations.
Conclusion:
MLP/midstream investment vehicles have evolved as the midstream world has changed, but investors still have access to a broad menu of active and passive funds and products to meet their investment objectives.
AMZ is the JPMCFC Alerian MLP Index ETN (Am JB) and ETRACS Quarterly Dividend 1.5x Leveraged Alerian MLP Index ETN (MLPR).
