While there has been some chatter about the Federal Reserve ending its quantitative easing programs early, interest rates continue to sit at near zero levels. As the agency has kept short-term rates ultra-low in order to spur the economy, investors looking for income have come up dry. Traditional stable income sources such as money market funds, CDs and short-term bonds continue pay next to nothing.
To that end, investors wanting to live off their savings seem to be “up the creek without a paddle.”
However, there are some solutions to finding stable income in this rock-bottom interest rate environment- if investors move outside their traditional comfort zone. Master limited partnerships (MLPs) represent an attractive investment option for income-focused investors. In addition to high yields, MLPs have relatively stable cash flows and solid growth potential. Adding a dose to a portfolio could be the cure for the income blues.
SEE: Discover Master Limited Partnerships
The Pipeline 411
While it was once a quirky asset class reserved for the wealthy, master limited partnerships have made it to the mainstream- or should I say midstream?
Most MLPs are pipeline firms and are in involved in business of processing and transporting of energy natural gas, crude oil, and other refined products across the country. These infrastructure companies' profits are generally based on the volume of oil or gas that flows through their pipes, not on what that liquid is worth. This removes much of the price swings that are associated with the commodities. As such, MLPs have relatively consistent and predictable cash flows. Many also feature regulated fee amounts with inflation adjustments, as well as "take or pay" contracts, which require users to pay regardless of whether the capacity is used.
Based on their corporate tax structure, MLPs pass on the bulk of their revenue to investors via big distributions as they do not pay taxes on the corporate level. This is similar to real estate investment trusts (REITS) and business development companies (BDCs). Shareholders- called unit holders- are rewarded with 6-7% average dividend yields and some other tax advantages.
These high yields and tax benefits are all well and good. However, they aren't without their own tax headaches. Because MLPs distribute not only dividends but also write-offs associated with their asset depreciation, instead of receiving a standard 1099 form, investors can expect a K-1 statement in the mail.
For investors, the recent exchange-traded products boom has allowed retail portfolios to tap the asset class without many of these nuisances come tax time.
SEE: The Benefits Of ETF Investing
Four Prime Pipeline ETFs
Tracking the main index for MLPs, the ALPS Alerian MLP ETF (ARCA:AMLP) could be the number one stop for investors. The ETF is a behemoth with $5.7 billion dollars in assets, spread among 25 different top MLPs, and yields 5.72%. Holdings include exposure to kingpins like Kinder Morgan (NYSE:KMP), Oneok (NYSE:OKS) and Access Midstream (NYSE:ACMP). The drawback to AMLP is that it is treated as c-corp. due to how the fund must be structured. That’s resulted in significant tracking errors to the index. AMLP has returned 22.34% since inception, while the Alerian index returned 38.37% as of the end of December. A potential solution to this problem would be the ETN structured UBS E-TRACS Alerian MLP Index ETN (ARCA:AMU).
For investors looking for highest yield possible, the Yorkville High Income MLP ETF (ARCA:YMLP) is for you. Paying a whopping 8.81% dividend, the fund bets on the “riskier” side of the MLP world. This includes propane providers like Ferrellgas Partners (NYSE:FGP) and production based firms like Vanguard Natural Resources (Nasdaq:VNR). Generally, these firms have higher and more variable distributions. As such, YMLP will be a more volatile fund for portfolios.
Finally, the Credit Suisse Cushing 30 MLP Index ETN (ARCA:MLPN) follows an equal-weighted strategy to produce returns. This strategy helps smooth-out the portfolio and prevents anyone firm from “taking over the fund” as they grow in size- or conversely shrink. While the yield is lower at 4.74%, it has produced double-digit returns over the last two years at 12.08%. That’s bested both AMLP and the YMLP.
SEE: ETF Or ETN? What’s The Difference?
The Bottom Line
For investors looking for income in the current low interest rate environment, master limited partnership exchange traded funds could be the ticket. High income and growth potential minus the tax headaches associated with MLPs makes ETFs the top choice to play the sector. The previous picks, along with the Global X MLP ETF (ARCA:MLPA) make ideal selections to play the sector's rich dividends.
At the time of writing, Aaron Levitt did not own shares in any of the companies or funds mentioned in this article.