It’s easy to see why income investors love master limited partnerships (MLPs). Designed as pass-through securities, MLPs kick back much of their cash flows and profits to investors as cold, hard cash distributions.
Those high distributions help MLPs often yield in the 5% to 7% range. Add in their other tax-deferral benefits and it’s simple to understand why income seekers have parked some serious moola in MLPs.
However, there have been some recent hiccups in the sector, and there have been some major dividend blow-ups at a few individual MLPs. With still some uncertainty in the sector, broader is definitely better.
Which is why using an MLP exchange-traded fund could be your best bet for income.
There are now 30 different MLP ETFs on the market place and they basically come in two flavors — ETFs and exchange-traded notes (ETN). Both have their advantages and disadvantages. But the one thing they have in common is big income potential.
For investors, making a play on one of these funds could be the best way to gain exposure to the big yields, while avoiding potential dividend blowups and sector issues.
Here are three MLP ETFs to buy for big dividends.
MLP ETFs for Big Dividends: Alerian MLP ETF (AMLP)
Dividend Yield: 7.5%
Expenses: 0.85%, or $85 per $10,000 invested
If you are going to be looking at ETFs that track MLPs, then you might as well go with the industry benchmark as your starting place. The Alerian MLP Infrastructure Index can be played with the most popular MLP ETF — the ALPS Alerian MLP ETF (AMLP)
The $8.5 billion AMLP tracks the 25 largest MLPS that get their cash flows from the transportation, storage and processing of energy commodities. We’re talking about pipeline and midstream firms. That’s a key distinction, as there are numerous firms in other natural-resource-related industries that have adopted the tax structure.
Investors have another reason to cheer. AMLP’s expense ratio has come down — by a lot. Open-ended funds technically aren’t allowed to own MLPs beyond a certain percentage of assets. In order to be MLP-focused, AMLP had to be structured as a C corporation. Essentially, the fund has to pay taxes on its holdings. That led to very high expense ratio- at one point over 8%!
But with sector losses, its deferred income tax expense is now zero and its expense ratio is only 0.85%.
MLP ETFs for Big Dividends: First Trust North American Energy Infrastructure Fund (EMLP)
Dividend Yield: 3.7%
The First Trust North American Energy Infrastructure Fund (EMLP) hopes to circumvent some of the issues with the previously mentioned AMLP when it comes to taxes.
EMLP isn’t 100% focused on just MLPs — the ETF is more of a total infrastructure package. And while midstream assets such as pipelines and gathering lines take the lion share of fund’s assets, the ETF does include firms such as natural gas utilities and electric power generators. EMLP also will include the MLPs’ general partners, which are generally structured as a C corporation.
EMLP charges just 0.95%.
The drawback is that EMLP doesn’t pay as much in the way of dividends, because more of its portfolio is in utilities and similar stocks. However, income investors shouldn’t fret. EMLP’s holdings such as Enterprise Products Partners L.P. (EPD) and TransCanada Corporation (USA) (TRP) still help the MLP ETF pay a decent 3.7% dividend.
The MLP ETF has been a decent performer as well, gaining around 9% annually since 2012.
MLP ETFs for Big Dividends: Direxion Zacks MLP High Income Shares (ZMLP)
Dividend Yield: 8.4%
ETF sponsor Direxion is best known for its suite of leveraged and inverse funds that allow traders to short or “juice” their performance. However, the firm has a whole suite of quality smart-beta and alternative ETFs under its umbrella. The Direxion Zacks MLP High Income Shares (ZMLP) is one of the most successful.
The fund tracks an index by investment ratings and information service Zacks. Zacks uses a quantitative rules-based screening process to sort MLPs by their value, liquidity, short interest, dividend yield and other factors to produce the portfolio. The MLP ETF’s goal is to create a portfolio that has the potential to outperform, on a risk-adjusted basis, the S&P 500 Index.
ZMLP tracks 25 different MLPs that are equally weighted. Currently, 59% of the ETF is in midstream and pipeline firms. The MLP ETF is then weighted equally. Because of its focus on yield, the ETF is full of “second-tier” MLPs. Not that there is anything wrong with MLPs like NuStar Energy L.P. (NS) or Holly Energy Partners, L.P. (HEP). It’s just that they don’t have the perceived safety and size of the sector’s larger stalwarts.
But that just means investors can pick a nearly 8.5% dividend yield from ZMLP — which uses screens to pick the best of these second-tier MLPs.
ZMLP charges 0.65% in expenses.
As of this writing, Aaron Levitt was long MMP.