Last week the Alerian MLP ETF (AMLP) announced a reduced quarterly distribution. Regular readers know that AMLP has been a rich source of material for this blog. Launched in 2010 when MLPs were synonymous with pipelines, it was designed to offer exposure to midstream energy infrastructure without the K1s that so many investors and their accountants dislike.  

Today MLPs represent about a third of the sector’s market cap. The narrow base of potential buyers has persuaded many former MLPs to convert to conventional c-corps, so as to be attractive to a much wider investor base. It also didn’t help that MLPs cut their dividends in half from 2015-20 – not the way to treat the traditional holders who were high net worth US taxpayers seeking stable income.  

AMLP’s recent 3.5% distribution cut is especially odd because it’s against the prevailing trend. Dividend hikes are becoming the norm, including at: Magellan Midstream (1%), Oneok (2.1%), Enterprise Products Partners (5.3%), Williams Companies (5.4%), Cheniere (19.7%), Targa Resources (42.9%) and Energy Transfer (54%). 

Since its 2010 launch through the end of June, AMLP has returned 2.61% versus its benchmark of 5.02%, a big underperformance for a passive ETF. Taxes are a big reason why. Alps, the fund’s advisor, has had to make two downward revisions to its NAV in the past year, both the result of recalculating the fund’s tax liability. AMLP is a corporate taxpayer, at least when it has unrealized gains on its portfolio. This unusual concession is necessary to jam MLPs into a ‘40 Act fund, which makes it a non-RIC compliant ETF.  

Because MLPs represent a declining share of the pipeline sector, AMLP’s number of holdings has been shrinking. They’re down to 14, and if Oneok’s acquisition of Magellan Midstream goes through that’ll knock them down to 13. They have an overweight to petroleum products – crude oil pipeline operator Plains All American is their biggest holding. They are underweight natural gas names, because most of them converted to c-corps. We prefer natural gas exposure over crude oil because it has a more robust growth outlook. Oil is primarily used in transportation.  

AMLP is also overweight smaller names, because there are so few MLPs to choose from. Crestwood (CEQP) is a 5.3% position, whereas it’s only 0.42% of the market as defined by the American Energy Independence Index. AMLP, ostensibly a passive ETF, has a 12X market weight position in CEQP because it has so few choices. 

Although global crude oil demand recently touched a record 103 million barrels per day, it is in the crosshairs of governments around the world adopting policies to reduce CO2 emissions. Natural gas is America’s biggest source of electricity generation at almost 40% and is used in many areas that solar and wind can’t serve, such as petrochemicals and fertilizer production. AMLP holders are unwittingly concentrating their exposure in the riskier part of the sector, because that’s where MLPs are.   

AMLP investors don’t just endure the drag of corporate taxes on the fund’s NAV versus its benchmark; they also face the uncertainty that those taxes have been calculated correctly. Last November (see AMLP Trips Up On Tax Complexity) and then again three months ago (see AMLP Has Yet More Tax Problems), Alps suffered the ignominy of disclosing a reduced NAV because of tax complexity. The two adjustments taken together wiped out the last three quarterly distributions.  

It’s unclear why AMLP’s distribution has dropped. Perhaps they have discovered yet more errors in their tax calculations. It remains the biggest ETF in the sector at $6.7BN, evidence that lethargy outweighs critical analysis among its holders. The characterization of its distributions as largely a return of capital used to appeal – this is common among MLPs because the tax code allows them to depreciate their assets even though their ability to generate earnings is growing. In effect MLP investors pay taxes on their distributions when they sell, at which point there’s a deferred income tax recapture. AMLP has in the past incorporated this appealing feature. 

However, this year its distributions have all been classified as income, meaning that taxable accounts have a tax liability this year. The changed nature of AMLP’s distributions coincides with the two NAV restatements, so it’s possible the tax analysis Alps has carried out is responsible. So AMLP now offers declining distributions wrapped in a vehicle that is taxed as a corporation, has restated its NAV twice in a year and no longer offers tax deferred distributions. If your financial advisor still holds AMLP in your account, you might want to see how much of this he really understands.  

We have three funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

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