The advisor’s guide to maximizing total return in midstream investments
Intermediate investing is well known for offering generous income, but surprisingly, that’s not the primary reason advisors allocate funds to it.
Aside from revenue generation and energy exposure, total return is the primary way most advisors use energy infrastructure in portfolios, according to “Energy Infrastructure 2022 Outlook: Inflation and Income Opportunities”. (Date: January 12, 2022. Sample size: 417 respondents, 36.2% RIA.)
Since there are many intermediate ETFs available to investors, each with their own nuances, it is important to consider what an investor wants to do for their portfolio when deciding where to allocate funds.
For investors looking to maximize total return, RIC-compliant MLP ETFs might be the best fit, according to Stacey Morris, CFA, Research Director at Alerian.
Regulated investment companies (RICs) are intermediary structures, acting as a conduit for income and gains for the end investor. To maintain their pass-through status, RICs cannot hold more than 25% of their assets in MLPs. A fund that owns more than 25% of MLP will not be treated as an intermediary but will instead be taxed like a corporation, according to Morris.
Energy infrastructure ETFs are either structured as RICs with MLP exposure capped at 25% (also referred to as RIC-compliant) or as companies with predominant MLP exposure. It is important to note that both types of ETFs provide a Form 1099 for tax reporting.
“Investors primarily looking for total return would likely be more interested in an RIC-compliant ETF,” Morris writes. “The total return potential is arguably better for RIC-compliant MLP ETFs, as there is no tax drag in periods of strong performance as there would be for C-Corp MLP ETFs.”
That said, positive developments in the MLP space in recent years, including significant free cash flow generation and the proliferation of buyout programs, have improved the total return potential of MLP-focused funds, Morris adds.
Another benefit of investing in RIC-compliant MLP ETFs is the greater diversification they bring to a portfolio.
According to Morris, consolidations of MLPs by parent companies, privatization deals and other M&A activity have reduced the number of investable MLPs, so investors who want broad exposure to energy infrastructure companies will prefer a RIC compliant product with MLPs and corporations.
For more news, insights and strategy visit the Energy Infrastructure Channel.