An ETN Option for MLP Investors
Master limited partnership exchange traded products generate attractive yields and provide exposure to the expanding North American oil industry, but investors may be better served with an exchange traded note.
“It’s rare for an exchange-traded note to be a viable alternative to an exchange-traded fund that tracks the same asset class, but the UBS ETRACS Alerian MLP Infrastructure ETN (MLPI) is one of these unusual cases,” writes Abby Woodham for Morningstar.
Woodham argues that MLPI has fewer structural complications than popular MLP ETPs, the Alerian MP ETF (AMLP) and JPMorgan Alerian MLP Index ETN (AMJ) .
Specifically, the analyst points out that AMJ capped creations in June 2012 as a way to limit costs. Since AMJ does not create new shares, the ETN is basically trading like a closed-end product, which can cause the note to trade at a premium to its net asset value. For instance, AMJ traded at a premium of 2% to 5% between March 2013 through September 2013. The ETN currently trades at a 0.12% discount to its NAV.
Additionally, AMLP is structured as a corporation, not registered under the Investment Company Act of 1940, since open-end funds are not allowed to hold more than 25% of their portfolios in MLPs. Consequently, AMLP has to pay taxes whenever it sells underlying investments, which drag’s on the ETF’s performance – AMLP and MLPI both track the Alerian MLP Index, but AMLP only gained 10.2% over the past year while MLPI rose 14.6%.
Nevertheless, Woodham notes that AMLP could outperform the ETN in a down market since an ETF can harvest its tax liability.
ETNs, unlike ETFs, do not hold physical shares of the underlying companies of the index. ETNs are an unsecured debt security that promises to pay out the value of the index at its maturity, along with any distributions. Since the note is a debt security, it is exposed to the default risk of the underwriting bank. [How MLP ETF Structures Affect Yields and Returns]
MLP ETN investors are issued a 1099 form instead of the MLP K-1s during tax season. However, investors should be aware that distributions on MLP ETNs are not tax-deferred and distributions are taxed as standard interest income. [MLP ETF Investors Should Know How Taxes Affect Returns]
“MLPI is best suited for investors who want to buy the total return of a diversified portfolio of MLPs while reducing their paperwork load,” Woodham said.
For more information on master limited partnerships, visit our MLPs category.
