Investment banking giant Morgan Stanley made its first foray into the exchange-traded product world this week, rolling out an ETN offering exposure to the MLP sector. The Cushing MLP High Income Index ETN (MLPY) will offer exposure to a criteria-weighted index tracking the performance of 30 MLPs that hold energy infrastructure and related shipping assets in North America. The effective weighting strategy results in approximately equal allocations to many of the underlying holdings; as of March 1, ten different securities made up between 4.85% and 5.16% of the related index.
The MLP ETP space has exploded in recent years; MLPY is the seventh product in the MLPs ETFdb Category, and UBS also offers inverse and leveraged options for this corner of the domestic energy market. Like most of the existing options, MLPY will be structured as an ETN, meaning that it is a debt security whose indicative value is tied to the performance of an index (in this case, the Cushing MLP High Income Index). Morgan Stanley is the issuer of the debt securities, meaning that investors in MLPY are exposed to the credit risk of the company. Other major ETN issuers include Credit Suisse, Barclays, and UBS [Do You Need An MLP ETN?].
MLP + ETP = Assets
Exposure to MLPs has become popular in part because of the competitive yields offered by this asset class–especially compared to the anemic current returns on many fixed income investments. In order to maintain certain tax advantages afforded to MLPs, these entities must pay out a certain percentage of earnings on a regular basis. And because demand for their services–generally related to the transport and storage of energy commodities such as petroleum and natural gas–is relatively inelastic, cash flow is fairly stable. The result is a current return well above what is delivered by even many ETFs focusing on dividend-paying stocks [see How To Find The Right Dividend ETF].
The current indicative yield of the index underlying MLPY at launch was 6.6%. According to Morgan Stanley, the 12 month dividend yield as of March 1 was 6.4% for the underlying index, eclipsing the Alerian MLP Index that serves as the basis for the ultra-popular AMJ by about 80 basis points. The comparable metric for the Dow Jones U.S. Real Estate Index was 3.9%, while the S&P 500′s dividend yield came in at 1.8%.
ETF vs. ETN
Achieving MLP exposure through the ETN structure is appealing because it allows for simplified tax reporting; investors in MLPY will receive a Form 1099 for coupon payments as opposed to a K-1 that would be required for a direct ownership interest in a limited partnership.
Last year ALPS introduced the first ETF to offer exposure to the MLP space, and AMLP has accumulated more than $800 million in assets during its relatively short life. There are both potential advantages and potential drawbacks to accessing MLPs through the ETF structure, with the primary benefit being a more tax-friendly treatment of distributions. The potential drawback, however, comes in the form of a deferred tax asset that accrues when the underlying securities appreciate in value [see When ETNs Are Better Than ETFs].
MLPY is the second product linked to a Cushing Index; the Credit Suisse Cushing 30 MLP Index (MLPN) is linked to the Cushing 30 MLP Index. The new ETN charges an annual fee of 0.85%, in line with other MLP ETPs already on the market.
Disclosure: No positions at time of writing, photo is courtesy of Luca Galuzzi.