Interest Rates

In addition to being prolific share issuers, MLPs are heavy users of debt. And expectations of rising interest rates—translating into higher cost of capital for MLPs—have contributed to price declines in the asset class. For example, Enterprise Products Partners LP (EPD) has $29 billion in long-term debt against $47 billion in total assets. Magellan Midstream Partners LP (MMP) has total liabilities of $3.6 billion against total assets of $5.5 billion. If interest rates rise, the firms’ debt costs will increase, and the firms will become less profitable.

The second reason interest rate increases will hurt is that the 6.59% yield of Enterprise Products and the 4.84% yield of Magellan will look worse against a 10-year Treasury yield of, say, 3% or 3.5%, rather than the 2.3% yield the government delivers to lenders now. But since the prices of MLPs have declined so much, their yields look a lot better than they did a year ago.

How To Get Exposure

Although it may be time to start nibbling at the asset class, the other vexing thing about MLPs has to do with the various methods of gaining exposure. According to an article by Goldsborough, there are 26 exchange-traded products, divided between ETFs and ETNs (exchange-traded notes). These two iterations function in meaningfully different ways.

Goldsborough says the largest MLP exchange-traded product is the Alerian MLP ETF (AMLP), but this one isn’t worth owning. Unfortunately, it has a whopping gross expense ratio of 5.43%, causing it to lag its underlying index by an annualized 4.6% since inception through June 30, 2015, which makes it unsuitable for most investors. 

The fund’s management fee is 0.85%, but it’s organized as a C corporation instead of as a ’40 Act fund. This helps it avoid the prohibition against funds having more than 25% of their assets in MLPs, and it allows the fund to pass a 1099 tax form on to shareholders instead of individual K-1 tax forms for all its holdings. Unfortunately, this structure also gives it some difficult tax burdens, which are reflected in its gross expense ratio. 

The next-largest MLP ETP, Goldsborough says, is the JPMorgan Alerian MLP Index ETN. Because this is an exchange-traded note, it avoids some of the tax issues found in the AMLP fund. As an ETN, the JPMorgan Alerian MLP (whose ticker is AMJ) perfectly tracks the market-cap-weighted Alerian MLP Index. It’s made up of the 50 largest MLPs and seeks to capture some 75% of the available MLP market capitalization. Its investors also receive 1099 forms.

The AMJ product has some problems, though. Its 0.85% annual fee depends on the volume-weighted average price of each MLP component in the ETN’s benchmark rather than on the index level. That means, “The actual cost could deviate from 0.85%,” says Goldsborough. Also, in 2012, J.P. Morgan capped creations of new shares in the product. The result is that it trades as a closed-end fund, with spreads between market price and net asset value. Supply and demand for the AMJ product became unbalanced, and its shares traded at premiums during 2013.

If bid-ask spreads widen again, Goldsborough’s suggestion is for new investors to consider another MLP-oriented ETP such as the UBS ETRACS Alerian MLP Infrastructure Index ETN (MLPI), which, like the AMLP fund, tracks the Alerian MLP Infrastructure Index. The MLPI note also charges a path-dependent, 0.85% annual fee. With fewer assets than the AJM product, this one can still create new shares.

Another MLP exchange-traded note that Goldsborough favors is the Credit Suisse X-Links Cushing MLP Infrastructure ETN (MLPN), again with a path-dependent 0.85% annual fee. Rather than tracking the Alerian MLP Index, the MLPN product tracks the equally weighted Cushing 30 MLP Index, composed of midstream MLPs. This index also includes some MLP general partners.

Investors should remember that ETNs contain counterparty risk because an ETN is essentially a debt instrument issued by a bank. So while an exchange-traded fund’s fees might be prohibitive, exchange-traded notes come with their own risks. Banks seem safer now than they were during the financial crisis, but investors should be aware of the possibility of institutional failure and its potential adverse effect on an ETN it has issued.

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