An investor's must-know guide to tracking error for MLP ETFs (Part 5 of 6)
The Yorkville High Income Infrastructure MLP ETF (YMLI)
The Yorkville High Income Infrastructure MLP ETF (YMLI) tracks the Solactive High Income Infrastructure MLP. In the graph below, we’ve shown how YMLI performed versus its benchmark index for year-to-date, six months, and one year.
The benchmark index constituents have market capitalizations greater than $1 billion and three-month average daily trading volume of $4 million. The fund invests at least 80% of its net assets, plus the amount of any borrowings for investment purposes, in the securities of MLPs. The index consists of MLPs operating in the exploration and production of oil or natural gas, the sale, distribution, and retail and wholesale marketing of propane, natural gas liquids, gasoline, and other fuels, marine transportation, direct mining, the production and marketing of natural resources, oil refining, and the land easing of mineral reserves.
The graph below shows the total returns from YMLI and its benchmark index in the past year.
The tracking error of YMLI is 4.66%. This means the standard deviation of excess average weekly returns for the benchmark index over YMLI for the past year is 4.66. Please note that the higher the tracking error, the higher the volatility of daily excess returns of the asset, or the ETF, in this case.
The divergence or volatility in returns between YMLI and its benchmark index can partly be attributed to the expense ratio. The management fee applicable to YMLI is 0.82% per annum. So the returns from YMLI will be reduced by 0.82%, while no such charges apply on the index returns, since the benchmark index is a theoretical entity and isn’t traded or exchanged. So YMLI will underperform its index by the expense ratio, all other factors remaining constant.
From the table above, we find that as of April 16, 2014, YMLI and its benchmark index don’t have the same MLP names in their top five holdings. Also, the percentage weighting of the holdings was different between the two portfolios. How the sampling effect of YMLI affects its returns is shown in the table below.
The effect of sampling—the difference in the holdings between YMLI and its benchmark index—is another cause of the tracking error. For example, as of April 16, 2014, Targa Resources Partners LP (NGLS) constituted 4.1% of YMLI’s total portfolio, while NGLS accounted for ~4.2% of the portfolio of its index. Year-to-date and one-year returns for NGLS are 17.2% and 34.8%, respectively. So the additional 0.1% (4.2% – 4.1%) holding of NGLS by the index translates into 0.04% and 0.09% of excess returns for the index with respect to YMLI for year-to-date and one-year periods. Readers may note that YMLI underperformed its index by 0.7% year-to-date and outperformed the index by 1.3% for the past six months. Similar calculations have been shown in the table for the other top holdings of YMLI.
The other reason for the variation of the performance of the ETF from its benchmark index is income tax. For federal income tax purposes, YMLI has been structured as a “C-Corp.” So YMLI accrues deferred tax liability for its future tax liability on the capital appreciation of its investments, and the distributions it receives on equity securities of MLPs are considered a return of capital. The deferred income tax expense (or benefit) represents an estimate of YMLI potential tax expense (or benefit) if it were to recognize the unrealized gains (or losses) in the portfolio. All realized and unrealized gains (or losses) on investments and expenses may vary greatly from year to year and from day to day, depending on the nature of the fund’s investments, the performance of those investments, and general market conditions.
The largest MLP ETF fund is the Alerian MLP ETF (AMLP), which tracks the Alerian MLP Index, AMZI, a capitalization-weighted composite of 25 energy infrastructure companies. Other MLP ETFs include the Yorkville High Income MLP (YMLP), the Global X MLP ETF (MLPA), the Yorkville High Income Infrastructure MLP ETF (YMLI), and the Global X MLP & Infrastructure ETF (MLPX). Note that these other MLP ETFs have significantly smaller market caps than AMLP.
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