Definitive Guide To MLP ETFs And ETNs

April 04, 2013

The ETN issues all distributions at an ordinary income tax rate, in the year in which those distributions are made. Clearly, $1 paid tomorrow is worth less than $1 paid today, tilting the scales, seemingly, in favor of the ETF/corporation structure. However, the comparison is not so simple, as the future taxes paid in the ETF structure will likely be determined at a higher aggregate tax rate due to the double tax created by the ETF. Consequently, comparing the ultimate tax efficiency of the structures requires assumptions regarding the length of the deferral as well as the appropriate discount rate. Further, assumptions must be made regarding whether some part of the ETF double tax could be minimized by using estate planning that allows a step-up cost basis in inheritances, essentially negating the capital gains tax that would be paid on the ETF units if the unit holder dies and the units pass to her heirs.

In conclusion, the choice of ETF/corporation versus ETN for MLP exposure involves assumptions about the time horizon, tax position and risk tolerance of the individual investor, combined with certain assumptions about the future returns of the MLP market.

But broadly speaking, an ETN makes most sense for MLP exposure if:

  • The investor expects the majority of total return to come from price appreciation.
  • The investor is using a tax-deferred account and cannot benefit from the tax deferral of the ETF structure.
  • The investor has a shorter time horizon.
  • The investor places a high value on transparency and predictable returns.
  • The investor is unconcerned about the credit risk of the note.
  • The investor is more concerned with total return than after-tax yield.


An ETF/corporation makes most sense for MLP exposure if:

  • The distribution yield of the MLP is greater than or equal to the MLP index total return. In this case, the tax-deferral overwhelms the performance hit of the internal tax issues; however, paying out a higher distribution than total return is likely unsustainable in the long run.
  • The investor has a very long time horizon, including potentially passing her position to an estate.
  • The investor uses a high discount rate to value future cash flows.
  • The investor has a low tolerance for credit risk.
  • The investor is comfortable with complex tax accounting and its associated risks.
  • The investor values tax efficiency over absolute returns or index tracking.


In either case, however, it’s important to understand that these exchange-traded products are not simple roll-ups of the value proposition from holding individual MLPs, and perhaps more than any other corner of the ETF market, a deep understanding of both the underlying asset class and the ETF structures is not just prudent, but necessary.

There are now 13 different MLP ETPs on the market, with more than $13 billion in AUM between them. Although there are some redundancies in underlying indexes, there are many distinct choices for those looking to fine-tune their exposure. These exposure differences, while important, should be the second step in your investment decision, with the first step being the choice of structure. It is this first step that will allow you to properly match your investment profile, objectives and expectations to the correct product.


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