Pipeline to Prosperity

In a world where traditional fixed income investments seem about as exciting as watching paint dry (with considerably less yield), midstream energy funds have emerged as the unsung heroes of the income investor's portfolio. These often-overlooked investment vehicles offer impressive yields that make government bonds blush, with the added benefit of exposure to critical infrastructure that keeps America's energy flowing.

Before diving in, it's worth addressing the elephant in the room: the dreaded K-1 tax form. Investing directly in master limited partnerships (MLPs) comes with significant tax complications. Unlike standard investments that provide a simple 1099 form, MLPs issue Schedule K-1s that can arrive frustratingly late (often in March or even April), delaying your tax filing. These forms are notoriously complex, often requiring professional tax preparation assistance, and may trigger state tax filing requirements in multiple states where the MLP operates. Even worse, holding MLPs in retirement accounts can potentially create unrelated business taxable income (UBTI), leading to unexpected tax bills within supposedly tax-advantaged accounts.

Fortunately, the funds we're about to explore solve these headaches by providing simplified 1099 reporting, making them far more investor-friendly while still capturing the impressive yields of the midstream sector.

Let's explore three standout options that could help turn your portfolio into an income-generating machine, without requiring either an engineering degree in pipeline maintenance or an accounting degree in partnership taxation.

The Case for Midstream Investing

Before diving into specific funds, let's understand why midstream energy infrastructure deserves a spot in your income strategy:

• Cash flow royalty: Midstream companies essentially serve as toll collectors on America's energy highways, earning steady fees regardless of energy price fluctuations

• Essential infrastructure: These assets represent the critical backbone of U.S. energy, with high barriers to entry

• Attractive yields: Current distributions typically range from 7-10%, dwarfing traditional income investments

• Inflation protection: Many contracts include inflation adjustments, providing a natural hedge

• Simplified taxation: Fund structures eliminate the dreaded K-1 tax forms that come with direct MLP ownership

Now, let's examine three compelling vehicles that offer access to this sector.

Why Choose Funds Over Direct MLP Investments?

Before diving into specific options, it's worth understanding why using funds to invest in midstream companies offers significant advantages over direct MLP ownership:

Instant diversification: Individual midstream MLPs can face company-specific challenges including operational issues, leverage concerns, or regional disruptions. Investing in a single MLP might offer a high yield, but it comes with concentrated risk. Funds spread your investment across multiple companies, pipelines, and geographies, providing protection if any single entity faces difficulties. This diversification can significantly reduce your risk without sacrificing much of the income potential.

Tax simplification beyond just avoiding K-1s: While avoiding the Schedule K-1 nightmare is a significant benefit (as detailed earlier), fund structures offer additional tax advantages. They eliminate the need to track cost basis adjustments that direct MLP investors must manage, prevent potential UBTI issues in retirement accounts, and spare you from filing tax returns in multiple states where the MLPs operate. With funds, your tax reporting is streamlined into a single 1099 form.

Professional management: Fund managers conduct detailed analysis of each midstream company's balance sheet strength, distribution coverage ratios, growth projects, and management quality. This expertise is particularly valuable in a sector with complex business structures and terminology that can be challenging for individual investors to navigate.

Enhanced liquidity: Individual MLPs can sometimes have limited trading volume, potentially creating challenges when you want to sell. Funds typically offer better liquidity, which is particularly important during market stress when trading in individual MLPs might become thin.

Access to corporate midstream companies: Many midstream businesses have abandoned the MLP structure in favor of C-corporation structures. Funds can include these non-MLP midstream companies alongside traditional MLPs, providing exposure to the entire sector rather than just a segment of it.

Let's examine three funds that offer these benefits while providing attractive income streams to investors:

ClearBridge Energy Midstream Opportunity Fund (EMO)

This closed-end fund has been flexing its income muscles with impressive performance and consistent distributions. Currently trading at $47.12 per share (as of May 16, 2025), EMO offers a compelling option for income-focused investors seeking midstream energy exposure.

Key advantages and current metrics:

• Strong forward yield: Currently offering a 9.17% forward yield with monthly distributions

• Impressive monthly income: Paying $0.36 per share monthly ($4.32 annually)

• Solid performance: Up 10.27% over the past year and showing exceptional longer-term returns

• Outstanding long-term results: 3-year price return of +278.46%, 5-year return of +314.96%

• Substantial asset base: Currently managing $936.07 million in assets

• Discount opportunity: Historically trades at a discount to NAV, offering potential capital appreciation

• Tax simplicity: Issues Form 1099 instead of complicated K-1s, making it retirement-account-friendly

• Professional management: Managed by Legg Mason Partners Fund Advisor, LLC, and co-managed by ClearBridge Investments with deep sector expertise

• Consistent distribution growth: 2.56% 5-year distribution growth rate (CAGR) with 3 years of growth

EMO was formed in 2011 and focuses on investing in energy midstream entities, including both partnerships and corporations. The fund invests at least 80% of its managed assets in energy midstream entities, emphasizing companies with long-life assets, predictable cash flows, and relatively low direct commodity exposure. Over the full span of the fund, it has underperformed the S&P500 when judged by total returns (price + income):

However, the one-year total returns comparison with S&P500 is much more favorable:

The fund's top 10 holdings (as of March 31, 2025) comprise 73.45% of the portfolio:

1. Energy Transfer LP (15.96%)

2. Targa Resources Corp (10.70%)

3. ONEOK Inc (8.73%)

4. MPLX LP Partnership Units (8.44%)

5. Western Midstream Partners LP (6.40%)

6. Enterprise Products Partners LP (5.59%)

7. Williams Companies Inc (5.37%)

8. Kinder Morgan Inc Class P (5.63%)

9. Hess Midstream LP Class A (4.67%)

10. Plains All American Pipeline LP (4.55%)

With a total of 21 holdings, EMO is somewhat concentrated but offers significantly more diversification than investing in individual MLPs or midstream companies. The fund maintains a focused approach that has delivered exceptional results, particularly over the 3-year and 5-year time horizons, where it has dramatically outperformed the S&P 500.

It's worth noting that EMO has a higher expense ratio (1.78%) compared to passive ETF alternatives, but its strong performance and professional management have more than justified this cost over time. For investors seeking a professionally managed midstream portfolio with simplified tax reporting and attractive monthly income, EMO offers a compelling case.

Westwood Salient Enhanced Midstream Income ETF (MDST)

The new kid on the block, MDST launched in 2024 with an innovative approach that has quickly attracted investor attention. This actively managed ETF combines traditional midstream investments with an options strategy to turbocharge its yield.

Key features and current metrics:

• Impressive double-digit yield: Currently offering a 10.00% trailing twelve-month yield as of May 16, 2025

• Monthly payouts: Provides $0.23 per share monthly distributions (annual payout of $2.70)

• Solid growth: Up 7.03% over the past year and 9.96% since inception

• Reasonable expense ratio: 0.80%, competitive for an actively managed strategy with options overlay

• Strong diversification: Portfolio of 99 holdings across the midstream sector

• Substantial asset base: Now managing $90.2 million, showing rapid adoption by investors

• Dual income sources: Combines dividend yield with options premium income

• Geographical diversification: Invests in both U.S. MLPs and Canadian midstream corporations

• No K-1 headaches: Simplified tax reporting for investors

MDST's investment strategy involves investing directly in MLPs and midstream corporations across the United States and Canada, while using options strategies to enhance income. The fund focuses on companies involved in energy infrastructure, including gathering and processing, liquefaction, pipeline transportation, rail terminaling, and storage.

The fund's top holdings reflect a balanced approach to the midstream sector (as of May 14, 2025):

1. Energy Transfer LP (8.85%)

2. Enbridge Inc (7.94%)

3. Williams Companies Inc (7.73%)

4. Kinder Morgan Inc (7.46%)

5. Enterprise Products Partners LP (6.47%)

6. ONEOK Inc (6.06%)

7. Antero Midstream Corp (5.14%)

8. Cheniere Energy Inc (5.09%)

9. DT Midstream Inc (4.85%)

10. TC Energy Corp (4.81%)

Unlike AMLP, MDST is actively managed by a team of experts at Westwood Management Corp. and Vident Asset Management, allowing the fund to adjust positions based on market conditions and opportunities. With its top 10 holdings comprising 64.4% of assets, MDST offers better diversification than some competitors while maintaining focused exposure to the sector's leading companies.

While MDST's short history (launched in 2024) means it lacks the long-term track record of some alternatives, its innovative approach and strong initial performance have already made it a compelling option for income-focused investors.

Over the history - MDST has out-performed the S&P500 based on total returns (price movement + income generation):

Alerian MLP ETF (AMLP)

Sometimes the classics endure for good reason. As the largest and most liquid midstream ETF, AMLP has become the de facto benchmark for the space since its 2010 launch.

Why Consider AMLP:

• Proven track record: Operating for over a decade through various market conditions, including dramatic oil price fluctuations

• Substantial yield: Currently offering approximately 7.85-8.0%

• Massive scale: With over $10 billion in assets, it offers excellent liquidity for easy entry and exit

• Pure-play exposure: Focuses exclusively on midstream MLPs earning most cash flow from transportation, storage, and processing

• Simplified tax reporting: Provides 1099 forms instead of K-1s, making it suitable for both taxable and retirement accounts

• Quarterly distribution schedule: Reliable income payments four times yearly

• Low fees relative to category: Ranks in the cheapest quintile among its peers according to Morningstar

AMLP tracks the Alerian MLP Infrastructure Index (AMZI), which consists of approximately 15-20 energy infrastructure MLPs. The fund is highly concentrated, with its top holdings typically accounting for over 60% of assets, giving investors significant exposure to industry leaders like Enterprise Products Partners (EPD), Energy Transfer (ET), and MPLX LP (MPLX).

Similarly to EMO (discussed above), AMLP total returns are reasonable over the last year but also seriously lag the S&P500 since inception.

Important cautions from Morningstar about AMLP:

A recent Morningstar analysis (Paywalled; March 2025) raises several significant concerns about AMLP that investors should carefully consider. Morningstar has assigned AMLP a "Negative" Medalist Rating, citing weaknesses in its People and Process Pillar ratings. This unfavorable assessment highlights several risk factors:

• Extreme concentration risk: Nearly 99% of the fund's assets are concentrated in just its top 10 holdings, far exceeding the category average of 63.4%. This lack of diversification amplifies company-specific risks.

• Persistent underperformance: Over the past 10-year period, AMLP has lagged its average peer by an annualized 51 basis points and trailed its benchmark by an annualized 87 basis points. More concerning, recent performance has deteriorated further, with the fund placing in the bottom 10% of its peer group over the past year.

• Management concerns: Morningstar notes the limited experience of the portfolio management team, which averages just seven years at this fund. The parent company (ALPS) has also received a Below Average Parent Pillar rating.

• Sustainability issues: The fund receives Morningstar's second-lowest Sustainability Rating (2 globes), indicating relatively high ESG risk compared to peers. It has 100% involvement in fossil fuels and high exposure (12.12%) to companies with severe controversies.

Additional drawbacks to consider:

• Higher expense ratio: At 0.85% annually, AMLP's fees are noticeably higher than many ETFs, eating into returns over time

• Tax inefficiency: The fund's unusual C-corporation structure creates a layer of taxation at the fund level, potentially reducing overall returns compared to direct MLP ownership

• Distribution volatility: The fund's payout history has seen periods of reduction during energy sector downturns

• Limited growth component: As a pure income vehicle focused on distributions, AMLP may underperform during periods of energy sector growth

• Commodity correlation: While less volatile than producers, AMLP still shows correlation with broader energy market trends

Despite these limitations, AMLP remains popular for its liquidity, straightforward approach, and consistent income profile. For investors seeking fundamental sector exposure without the complexity of direct MLP ownership, it provides a well-established option, though the Morningstar analysis suggests that actively managed alternatives might deserve stronger consideration for those seeking exposure to this sector.

Source: [Paywalled] Morningstar AMLP Analysis (March 2025)

Why These Investments Make Sense Now

Income investors face a challenging environment: traditional fixed income still offers modest yields despite rate cuts, dividend aristocrats trade at premium valuations, and high-yield bonds come with significant credit risk. Midstream energy infrastructure funds offer a compelling alternative:

1. Income that matters: With yields in the 7-10% range, these investments generate meaningful cash flow

2. Infrastructure exposure: Critical assets with high barriers to entry provide essential services

3. Volume-based business: Revenue is often tied to throughput volume rather than volatile commodity prices

4. Growth potential: Expanding U.S. energy production requires additional infrastructure capacity

5. Simplified tax treatment: Fund structures eliminate the complexities of direct MLP ownership

Considerations Before Investing

Like any investment offering above-average yields, these funds aren't without risk:

• Energy sector exposure: While less volatile than producers, midstream companies still correlate somewhat with energy markets

• Interest rate sensitivity: As income vehicles, they may face pressure during rising rate environments

• Regulatory risks: Pipeline approvals and environmental policies can impact growth opportunities

• Distribution sustainability: Always evaluate the coverage ratios and balance sheet strength

The Bottom Line

For income-focused investors willing to venture beyond traditional fixed income, midstream energy funds offer a compelling combination of substantial yield and exposure to essential infrastructure. Whether you prefer the active management and enhanced distributions of EMO and MDST or the straightforward approach of AMLP, these vehicles provide access to a sector that's literally fueling America's energy future.

The pipeline to prosperity might just run through your portfolio.

Disclaimer: This article is for informational purposes only and does not constitute investment advice. Always conduct your own research and consider your financial situation before making investment decisions.