What distinguishes different types of RIC funds is what they do with the other 75 percent of the portfolio not invested in MLPs. Some limit their non-MLP holdings to general partner and other U.S. midstream corporations—meaning that the remaining 75 percent of their holdings are invested in just one- quarter of the midstream universe. Still other RIC funds include a substantial fixed income allocation, potentially boosting yield but increasing their interest-rate sensitivity and foregoing possible equity returns in the process.

Diversified equity RIC funds invest across the entire midstream equity space and, in our view, provide the greatest flexibility to generate strong total return potential in midstream equity investments.

#2 C-Corp Dividends May Not Be What They Seem

Most C-corp MLP funds employ managed distribution policies and have maintained high payouts in recent years—despite substantial distribution cuts across the MLP market—by returning capital to shareholders.

The Alerian MLP ETF (AMLP), an exchange-traded fund, can serve as a useful proxy for the MLP industry. Since the end of 2015, AMLP’s dividend per share has declined by nearly 31 percent, as many MLPs have cut distributions to retain capital to fund their growth. AMLP’s cuts stand in stark contrast to most C-corp funds, where distributions have remained largely unchanged during the past few years (Exhibit 2).

In our view, most C-corp funds do not have the underlying earnings power to support their current payout—and ultimately, we believe, these funds will elect to cut their dividends.

Many RIC funds, including Cohen & Steers MLP & Energy Opportunity Fund (MLOAX), have pay-what-it-earns distribution policies. Such policies may entail some volatility in the amount of distributions paid each quarter, but in our  view represent a healthier way to invest in the asset class. Having gone through the process of cutting dividends, we believe this will allow the RIC funds to continue to participate in the midstream growth story going forward.

#3 C-Corp Funds May Suffer From Stealth Taxes

Even factoring in lower corporate tax rates as a result of the Tax Cuts and Jobs Act, C-corp funds remain at a tax disadvantage relative to RIC funds. As taxable entities, C-corp funds must record the future tax obligation on any unrealized gain, including increases in an investment’s value and return-of-capital distributions. Investors generally overlook this tax—recorded as a deferred tax liability (DTL)—as it is subtracted from the fund’s net asset value (NAV), resulting in a higher gross expense ratio and reduced performance.

These DTLs may result in double taxation—once at the fund level on unrealized gains and again at the individual level on any realized gains when the shares are sold, in addition to taxes on ordinary income distributions. The added DTL obligation may reduce an investor’s after-tax return in a rising market.