The Hidden Cost of Master Limited Partnership ETFs: Kinder Morgan Inc (KMI) and More

How ETFs simplify taxes — at a price
The benefit of owning exchange-traded MLP products is that they avoid many of these tax complications. In particular, the Yorkville High Income MLP ETF and the pioneering Alerian Mlp (NYSEARCA:AMLP) both promise the convenience of 1099s rather than complex K-1 filings.

The problem comes from the way in which these ETFs achieve that goal. Unlike most ETFs, which are registered investment companies that are also exempt from having to pay fund-level taxes, these MLP ETFs are structured as regular C corporations.

The benefit of this structure is that it interposes a taxable entity between ETF shareholders and the MLPs that avoids investors having to deal with K-1s. The ETF has to handle the partnership tax issues, paying dividends to shareholders on regular 1099s.

There’s a big trade-off, though. C-corporation ETFs have to pay corporate tax on their profits. In order to reflect their tax liability, MLP ETFs adjust their net asset values upward or downward on a daily basis. The new Yorkville ETF’s prospectus doesn’t state a specific percentage by which it adjusts for deferred tax liability, making the adjustments far less transparent to investors, but the older Yorkville High Income MLP fund computes taxes based on the current corporate tax rate of 35%.

The result is that MLP ETFs underperform the MLPs they own by roughly the percentage that goes to corporate-level taxes. Over the past several years, that has added up to huge shortfalls for the MLP ETFs with longer histories compared to the MLP indexes that these ETFs usually use as benchmarks.

Is the cost worth it?

Of course, for some investors, giving up more than a third of your prospective gains might seem worth it to avoid the tax hassles of owning MLPs directly. But exchange-traded note alternatives JP Morgan Alerian MLP ETN (NYSEARCA:AMJ) and UBS E-Tracs Alerian MLP ETN give investors a different way to avoid K-1s without the big drag on returns, albeit with the introduction of issuer credit risk from ETNs.

In the end, you have to decide whether the cost of MLP ETFs is worth the benefit. To make a smart decision, you have to take all the costs into account, including returns lost to taxes.

The article The Hidden Cost of Master Limited Partnership ETFs originally appeared on Fool.com and is written by Dan Caplinger.

Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Kinder Morgan. The Motley Fool owns shares of Kinder Morgan.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

5 Retirement Mistakes To Avoid (and Einstein’s Famous Quote)

11 Smartest People in the World

6 Films About the Financial World You Need To Watch (While “The Wolf” is Not Around)

Warren Buffett and Billionaires Are Crazy About These 7 Stocks

The Top 10 States With Fastest Internet Speeds

10 Best Places to Visit in USA in August

Top 10 Cities to Visit Before You Die

Top 10 Genetically Modified Food In the US

15 Highest Grossing Movies Opening Weekend

5 Best Poker Books For Beginners

10 Strategies Hedge Funds Use to Make Huge Returns

Top 10 Fast Food Franchises to Buy

10 Best Places to Visit in Canada

Best Summer Jobs for Teachers

10 Youngest Hedge Fund Billionaires

Top 10 One Hit Wonders of the 90s

Fastest Growing Cities In America

Top 10 U.S. Cities for Freelancers

Top 9 Most Popular Free iPhone Apps

Top 10 Least Expensive Private Business Schools in the US

Top 15 Most Expensive Countries in the World – 2014

Top Businesses to Invest In

Top 5 Things You Might Be Doing Wrong With Your Business

Top 5 Strategic Technology Trends in 2014

Top Rags to Riches Stories

Parenting Behavior That Promotes Future Leaders

Top 5 Mistakes Made by Small Businesses

Top 5 Most Common and Potentially Devastating Financial Blunders

Top 5 Highest Paying Jobs for Web Designers

Top 6 Most Respected Professions that Also Pay Well

Top 5 Pitfalls Investors Should Avoid

Top 6 Lawyers and Policy Makers Under 30

Top 6 New Year’s Resolutions for Entrepreneurs

Top 7 Locations to Check in on Facebook

Top 5 Mistakes made by Rookie eBay Sellers

Top 7 eBook Publishers in 2013

Top 6 Health Industry Trends in 2014

5 Lessons for Entrepreneurs from Seth Godin

Top 5 Success Tips from Jordan Belfort – the Wolf of Wall Street

Best Master’s in Finance Degree Programs

Top 6 Earning Celebrities Over 50

The most expensive sports to play

Top 7 Earning Celebrities Under 25

Best 7 Online Courses to Take: Free Finance MOOCs

Top 6 Bad Habits that Promote Failure

20 Most Valuable Soccer Teams in the World in 2013

12 Most Expensive Countries for Foreign Students

Top 30 Most Influential Women in the World

Top 20 Most Expensive New Year Eve Shows

Top 5 Best Vocational Careers

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!