by on June 15, 2010 | ETFs Mentioned:

Product development activity in the ETF industry continues behind the scenes at an impressive pace. ALPS Advisors, the firm behind the Equal Sector Weight ETF (EQL), recently filed details on a new exchange-traded product that would be linked to the Alerian MLP Infrastructure Index. That benchmark consists of Master Limited Partnerships (MLPs) that earn at least 50% of distributable cash flow from energy infrastructure hard assets that are not directly exposed to commodity prices.

MLP investing has seen a surge in popularity in recent years, thanks in part to the introduction of several exchange-traded products focusing on the space. JP Morgan introduced the Alerian MLP Index ETN (AMJ) in early 2009, and the note quickly became one of the most successful new ETPs of the year; assets currently stand at about $1.2 billion. So far in 2010, two new MLP products have already hit the market; UBS launched the E-TRACS Alerian MLP Infrastructure Index (MLPI) in April and Credit Suisse introduced the Cushing 30 MLP Index ETN (MLPN) about two weeks later.

The proposed ALPS product would be linked to the same index that underlies MLPI, but would be unique from existing products on the market in that it would be structured as an ETF, not an ETN. Because ETNs are subordinated debt securities, they carry credit risk. They also tend to minimize tracking error, since the fund manager isn’t required to reshuffle holdings or conduct transactions on the open market.

Offering popular ETNs in an ETF wrapper seems to be a new strategy in the industry; earlier this year, Jefferies Asset Management filed for approval on an ETF that would seek to replicate the performance of a benchmark comprised of futures contracts on the CBOE Volatility Index (or “VIX”). Two VIX ETNs from iPath, the S&P 500 VIX Short-Term Futures ETN (VXX) and S&P 500 VIX Mid-Term Futures ETN (VXZ) have also been among the most successful products to launch over the last two years.

The Case For MLPs

With well more than $1 billion in aggregate assets, energy MLPs have burst on to the scene . The products currently on the market–AMJ, MLPI, and MLPN–are linked to benchmarks that consists of companies engaged in the operation of energy infrastructure assets, including pipelines that transport crude oil, natural gas, and other refined petroleum products. Most of these companies generate fee-based revenues, which tend to not be directly tied to changes in commodity prices. In the current low-yield environment, investors have embraced MLP ETNs for the attractive dividend payments; MLPI, for example, was recently delivering a current yield of about 7% (see Five ETFs For Yield Hungry Investors).

MLPs have become so popular in investor portfolios in part because of the favorable tax treatment. By generating at least 90% of income from natural resource-based activities such as transportation and storage, an entity can qualify as an MLP and not be taxed as a corporation. So the IRS treats shareholders of an MLP as partners, making the MLP itself a pass-through entity. That means that taxes are avoided at the corporate level, and investors avoid the double taxation of income.

Disclosure: No positions at time of writing.