New Breed of MLPs: High Yield without Tax Hassle

Last Updated Jun 1, 2010 9:59 AM EDT

Wall Street is busy repackaging Master Limited Partnerships (MLPs) to attract a burgeoning retiree market starved for yield. With payouts of 6 percent or so, MLPs are tailor made for income-hunters frustrated with 1 percent bank rates and a Treasury yield curve that pays 4 percent only if you're willing to venture out to the 30-year bond.

But until recently, MLPs were a major tax hassle that kept away many investors. MLPs issue a K-1 tax form that complicates the tax filing process. As if, that needs to be any more complex. But a new breed of MLP Exchange Traded Notes (ETNs) and mutual funds are being rolled out that spare investors the K-1, making their payouts instead through a standard 1099 tax form. Now you can get the high yield of MLPs without the tax hassle. (If you were around in the late 70s and 80s when MLPs were all the rage before they crashed and burned, today's MLPs are a cleaned-up version thanks to an overhaul of tax law in the late 80s)

In the year since it launched, the JP Morgan Alerian MLP Index ETN (AMJ) has already grown to $1.2 billion in assets, thanks in large part to a magnetic 6.1 percent yield. No surprise, two other ETNs have recently hit the market, UBS E-TRACS Alerian MLP Infrastructure ETN (MLPI): and Credit Suisse Cushing 30 MLP Index ETN (MLPN): And last month three mutual funds focused on high-yielding MLPs were launched by SteelPath; the recently spun off investment arm of Alerian, the leading indexing force in the world of MLPs.

All these new MLP plays offer the easy 1099 tax form, and dividend payouts that are taxed at the lower "qualified" rate of 15 percent, rather than as income. The three SteelPath funds are too pricey for my taste, with a 5.75 percent front-end load and expense ratios north of 1 percent.

Before You're Blinded by the Yield
Okay, before you start dancing a yield jig, slow down. First off, we're talking about a one-industry play. The MLPs in these ETNs and funds are energy-sector firms that specialize in the storage and transport of natural resources. So right off the bat you've got a diversification issue.

And these are stocks. Not bonds. Sure, the whole idea with MLPs is that they are backed by steady cash flow. But that's no guarantee. Like any non-diversified investment, MLPs should be limited to a small slice of your overall portfolio.

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