Energy is far and away the best-performing sector in the S&P 500. That’ll happen when geopolitical turbulence sends oil prices soaring and one of the predictable effects of that scenario is some income-hungry clients are increasingly inquisitive about master limited partnerships (MLPs).
That’s not surprising when considering the dividend yield on the Alerian MLP Infrastructure Index (AMZI) is 7.44% and midstream energy equities can experience periods of not being tightly correlated to oil and natural gas prices. Advisors should relish increased chatter about energy equity income because this asset class can confound clients when it comes to taxes.
Put simply, many clients don’t realize that MLPs and the related funds should be held in taxable accounts, not tax-advantaged accounts such as IRAs. It boils down to the Unrelated Business Taxable Income (UBTI) tax and the ability of investors to defer losses until they sell their MLP units (shares).
“It is generally recommended that MLPs are held in taxable accounts because any distributions over $1,000 in a retirement account could result in Unrelated Business Taxable Income (UBTI) tax,” notes Cray Kaiser. “This is a special tax accessed by the IRS and would cause additional fees charged by your brokerage. Both of these would reduce the appeal of the MLP structure.”
A Potent MLP ETF
For many clients and income investors, MLP ETFs are more practical than individual names in this space because stock-picking is burdensome and not all midstream operators are cut of the same high-quality cloth.
A fresher fact to consider is the Westwood Salient Enhanced Midstream Income ETF (ticker: MDST), which turned two years old last month. To little fanfare, this is an almost $254 million ETF that’s up 13% year-to-date with a dividend yield north of 9%. MDST’s income proposition is enhanced via an options overlay. Translation: the fund’s managers aim to reduce beta and volatility by selling monthly call options that are typically 4% to 5% out of the money.
The combination of MDST’s options overlay and the status of the fund as an actively managed product may be appealing to clients at a time when inflation remains stubbornly elevated, potentially boxing the Federal Reserve into a no rate cut corner.
“Many MLPs operate in sectors naturally linked to inflation, such as energy transportation. As inflation rises, they can adjust their rates or fees, potentially leading to growing distributions over time,” observes Westwood.
More MDST Benefits
As the MDST’s year-to-date performance confirms, clients and investors can command capital appreciation in the midstream energy segment, particularly when embracing the right strucutures including active management.
The union of active management and midstream energy benefits end users on multiple fronts, including potentially dodging distribution cutters and increasing exposure to MLPs that aren’t highly correlated to energy commodity prices. So consider raising a glass to MDST and the ETF wrapper.
“One way to invest in MLPs would be to use a professional investment manager, who has the experience and tools to research individual MLPs and build a diversified portfolio,” adds Westwood. “You can invest in this asset class through a mutual fund or an ETF, which would allow you to invest in a diversified portfolio of several companies with one simple purchase.”
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