High-Yield Energy ETFs MDST and WEEI: A Delicate Balance of Income and Risk

The energy sector has long been a magnet for income-seeking investors, but few instruments push the envelope like Westwood's MDST and WEEI ETFs. These funds promise annualized distributions of 10.2% and 13.5%, respectively, yet their sustainability hinges on a precarious mix of covered-call strategies, return of capital (ROC), and volatile energy markets. Let's dissect whether these yields are a sustainable treasure or a ticking time bomb.

The Allure of High Yields: A Closer Look

Both ETFs—MDST (Westwood Salient Enhanced Midstream Income ETF) and WEEI (Westwood Salient Enhanced Energy Income ETF)—attract investors with headline-grabbing distributions. However, the fine print reveals a critical detail: 100% of the current distributions are classified as ROC. This means investors are receiving a portion of their initial investment, not income from dividends or capital gains. While this boosts short-term payouts, it erodes net asset value (NAV) over time, a risk that cannot be ignored.

The Sustainability Question: SEC Yields vs. Reality

The 30-Day SEC Yield, a more conservative measure of income generation, tells a different story. As of March 2025, MDST's SEC yield was 3.69%, and WEEI's was just 2.34%—both far below their headline rates. These figures exclude option premiums from covered calls, which artificially inflate distributions. To sustain the 10%-plus yields, the funds must continually return capital or secure favorable market conditions.

The Covered-Call Double-Edged Sword

Both ETFs use covered-call strategies to boost income. Selling call options on holdings generates premiums but caps upside potential if energy stocks rally. While this strategy can stabilize income in flat or declining markets, it leaves investors exposed if energy prices surge—a scenario that could backfire in a bullish market.

For instance, if oil prices rise sharply, the ETFs' gains would be capped by their sold call options, while the broader energy sector might outperform. Conversely, in a downturn, the option premiums provide a buffer—but not enough to offset losses from falling NAV.

Sector Risks: A Volatile Dance with Energy Markets

The funds' heavy exposure to the energy sector amplifies risks. MDST focuses on midstream infrastructure (pipelines, storage), while WEEI spans producers, refiners, and service firms. Both face headwinds:

• Commodity Volatility: Oil and gas prices are hostage to geopolitical tensions, OPEC policies, and global demand shifts.
• Regulatory Pressures: ESG trends and climate policies could disrupt MLPs and fossil fuel producers.
• Interest Rate Sensitivity: High-yield funds often struggle in rising rate environments, as bond alternatives become more attractive.

Performance: A Mixed Bag of Returns

Since their 2024 launches, MDST has delivered a 22.95% NAV return, outperforming WEEI's modest 4.05%. However, WEEI's broader holdings in large-cap names like Exxon (XOM) and Chevron (CVX) may offer stability, while MDST's MLP-heavy portfolio faces tax complexity and operational risks.

Investment Considerations: Proceed with Caution

1. Income Seekers: These ETFs may appeal to investors prioritizing high payouts, but they should recognize that ROC distributions reduce principal.
2. Time Horizon: Short-term holders risk NAV erosion; long-term investors must weigh the potential for energy sector recovery against structural risks.
3. Alternatives: Consider lower-risk energy income vehicles, such as utility stocks or MLP ETFs with less reliance on ROC.

Final Verdict

MDST and WEEI are high-octane instruments for income-focused investors willing to accept significant risks. Their covered-call strategy and ROC-heavy distributions create a high-reward, high-risk profile. While the funds have delivered returns in volatile markets, their long-term viability depends on energy sector stability and the ability to generate sustainable income beyond returning capital.

Recommendation:
- Hold: If you're comfortable with ROC erosion and have a long-term energy bullish thesis.
- Avoid: If you prioritize capital preservation or prefer dividends over artificial yield boosts.

Investors should monitor distributions closely—should the ROC percentage rise further or NAV decline sharply, these ETFs could face a reckoning. In a market where energy's fortunes swing like a pendulum, patience and risk awareness are paramount.