High-Yield Energy ETFs and the Risks of Return of Capital Distributions

The energy sector has long been a magnet for income-seeking investors, but the recent performance of Westwood’s high-yield ETFs—WEEI and MDST—reveals a troubling paradox. These funds promise double-digit annualized distribution rates, yet their reliance on return of capital (ROC) distributions raises urgent questions about sustainability and risk. In a market where volatility is the norm, investors must scrutinize whether these yields justify the erosion of principal and the structural limitations of the underlying strategies.

The Allure and the Illusion of High Yields

Westwood’s WEEI and MDST employ a hybrid approach: combining dividend income from energy stocks with covered-call options premiums to generate monthly payouts. As of July 2025, WEEI offers a 12.8% annualized distribution rate, while MDST provides 10.2% [1]. These figures are enticing, especially in a low-interest-rate environment. However, the reality is stark: 100% of current distributions for both ETFs are classified as ROC, meaning investors are effectively receiving a portion of their initial capital rather than income from dividends or capital gains [2]. This structure, while legal, erodes the net asset value (NAV) over time, creating a hidden cost for long-term holders.

The disparity in performance between the two ETFs further complicates the picture. MDST, focused on midstream energy infrastructure, has delivered a 17.99% NAV return since inception, while WEEI, which tracks the broader energy sector, has posted a -2.30% return [3]. Midstream assets—pipelines and storage facilities—are inherently less volatile than upstream producers, which face commodity price swings and operational risks. Yet both ETFs share the same ROC-driven payout model, which amplifies the risk-reward asymmetry.

The Sustainability Quandary

The 30-Day SEC Yield—a more conservative measure of income sustainability—underscores the gap between headline yields and reality. For MDST, it stands at 3.69%, and for WEEI, 2.34% [1]. These figures, significantly lower than the stated annualized rates, reflect the true income-generating capacity of the funds. The discrepancy arises because ROC distributions are not taxed as income but as a return of principal, which may defer capital gains taxes but does not mitigate the long-term erosion of NAV.

The covered-call strategy, while designed to reduce volatility, also limits upside potential. If energy prices surge, the ETFs’ ability to capitalize on gains is capped by the options premiums they sell. For WEEI, this constraint is particularly problematic given its underperformance. A -2.30% NAV return since launch suggests that the fund’s strategy has failed to offset the drag from ROC distributions and market exposure [3]. In contrast, MDST’s 17.99% return indicates that midstream infrastructure’s stable cash flows can partially offset the NAV erosion, but this does not guarantee future success.

Risk Metrics and Market Sensitivity

While MDST’s 1.10% quarterly standard deviation and 16.02% 20-day volatility suggest moderate risk, the absence of a beta metric leaves unanswered questions about its sensitivity to broader market movements [3]. WEEI’s strategy, which aims for 10-20% lower volatility than the S&P Energy Select Sector Index, lacks concrete data to validate its effectiveness [1]. In a sector prone to sharp swings, such ambiguity is a red flag. Investors must ask: How much of the ETFs’ returns are attributable to their strategies versus the inherent stability of their underlying assets?

Conclusion: A Cautionary Tale for Income Investors

The high yields of WEEI and MDST are not inherently flawed, but their reliance on ROC distributions creates a structural vulnerability. For WEEI, the -2.30% NAV return since inception and the 100% ROC payout model suggest a strategy that prioritizes short-term income over long-term capital preservation. MDST’s stronger performance offers some reassurance, but its similar distribution structure means it is not immune to NAV erosion.

In today’s volatile energy market, investors must look beyond headline yields. The true test of these ETFs lies in their ability to sustain distributions without compromising principal—and in WEEI’s case, to reverse its negative trajectory. Until then, the risk-reward tradeoff remains skewed toward risk.

**Source:[1] High-Yield Energy ETFs MDST and WEEI [https://www.ainvest.com/news/high-yield-energy-etfs-mdst-weei-delicate-balance-income-risk-2506/][2] High-Yield Energy ETFs MDST and WEEI [https://www.ainvest.com/news/high-yield-energy-etfs-mdst-weei-delicate-balance-income-risk-2506/][3] Westwood Announces Monthly Income Distributions [https://www.stocktitan.net/news/WHG/westwood-announces-monthly-income-distributions-for-westwood-salient-y2b9005dyj2x.html]