Do You Need An MLP ETF?

by on June 17, 2010 | Updated November 8, 2012

Few would argue that the impressive arrival of ETFs over the last several years has permanently changed the investment landscape. The attractive expense profile of these securities often gets the most attention; the relatively low expense ratios offered have caused investors to rethink the merits of traditional mutual funds, as investors have embraced passive indexing over active management (see True Cost Of Active Management). But the rise of the ETF industry has also significantly increased the popularity of certain asset classes in retail investor portfolios. Countless futures-based commodity products offer exposure to everything from corn to copper, while physically-backed precious metals funds allow investors to essentially own a share of a gold bullion bar. There are even ETFs offering hedge fund replication strategies, something previously reserved for large institutional investors [Download 101 ETF Lessons Every Financial Advisor Should Learn].

Another corner of the investable universe that has seen a surge in popularity thanks to exchange-traded products is the Master Limited Partnership (MLP) sector. Since JP Morgan introduced the Alerian MLP Index ETN (AMJ) in early 2009, the note’s assets have grown to more than $1.2 billion, and both Credit Suisse and UBS have introduced similar products (ALPS is planning an ETF version of these products as well). These ETNs have been embraced by investors because they offer unique exposure to the domestic energy industry, and can among the highest-yielding securities available.

MLPs are publicly-traded limited partnerships, the vast majority of which operate in the energy infrastructure industry. Many of these companies own and operate assets such as natural gas or crude oil pipelines. But while the operations of these firms are closely tied to oil and gas, revenues aren’t necessarily dependent on commodity prices. Because MLPs generate fee-based revenues, the correlation to the market price of crude or natural gas tends to be lower than a fund such as XLE that offers exposure to large oil companies.

MLPs can benefit from some favorable tax treatments. 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 and allowing investors to avoid double taxation of earnings [see 1,400+ ETFdb Realtime Ratings].

Allocations to MLPs have become popular perhaps because of the impressive yields offered by these securities. With interest rates expected to remain at record lows for the foreseeable future and corporations slashing dividends to preserve cash, investors who depend on their portfolio to deliver current return have encountered a challenging environment. The MLP ETNs profiled below have recently been offering current yields as high as 7%, an impressive payout that can be matched perhaps only by junk bonds (see Five ETFs For Yield Hungry Investors).

MLP ETN Options

Currently, there are three ETNs offering exposure to the MLP sector, although ALPS recently filed details on a MLP ETF that would invest in the underlying securities (ETNs are subordinated debt securities, and as such incur some degree of credit risk).

  • JP Morgan Alerian MLP Index ETN (AMJ): The first ETN to offer exposure to the MLP sector, AMJ is linked to the Alerian MLP Index. Major holdings in this cap-weighted benchmark include Enterprise Products Partners, Kinder Morgan, and Plains All American Pipeline.
  • UBS E-TRACS Alerian MLP Infrastructure Index (MLPI): This ETN tracks the Alerian MLP Infrastructure Index, a benchmark that has considerable overlap with AMJ. The 25 components of the infrastructure index each earn at least 50% of EBITDA from assets that are not directly exposed to changes in commodity prices.
  • Credit Suisse Cushing 30 MLP Index (MLPN): This ETN is linked to the Cushing 30 MLP Index, a benchmark that is unique from those tied to AMJ and MLPI. MLPN’s index is equal-weighted, meaning that it avoids concentrating exposure in a handful of larger companies.

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Disclosure: No positions at time of writing.