by Aaron Levitt | July 20, 2012 11:49 am
Sometimes success comes at price.
Driven by the Federal Reserve’s low interest policies, investors looking for yield have now become accustomed to adding some “exotic” assets to their portfolios. One such asset class that has gained in popularity has been pipeline master limited partnerships, or MLPs.
Featuring high tax-advantaged distributions, interest in MLPs has surged in the past few years. However, that popularity has its drawbacks. While the sector isn’t necessarily overvalued, one of the key ways for investors to add this income-producing asset class has recently undergone some major growing pains.
With nearly $5.1 billion in assets, the JPMorgan Alerian MLP Index ETN (NYSE:AMJ) has been the go-to investment for investors seeking high MLP dividends in their portfolios. The exchange-traded note tracked a basket of various pipeline firms such as Linn Energy (NASDAQ:LINE) and Magellan Midstream Partners (NYSE:MMP) and paid a hefty 5% to 6% dividend. The beauty of the ETN structure is that coupons paid from the note are reported on 1099 forms come tax time, and eliminate the administrative burden associated with K-1 forms that come with owning individual MLPs.
This tax-efficient nature helped explain why the note attracted so much in the way of investor attention. However, that popularity ultimately led to a big issue with the fund. Note sponsor JPMorgan Chase (NYSE:JPM) recently capped the size of the note at 129 million shares. The share creation and redemption feature of ETNs and ETFs is what keeps them close to their underlying net asset values.
By capping the number of shares, AMJ has now boosted the odds that the security’s price might become unhinged from its value and trade at a huge premium. When those price premiums collapse, investors end up losing big. Investors in the VelocityShares Daily 2x VIX Short Term ETN (NYSE:TVIX) saw the fund lose more than 50% of its value as its premium vanished. Likewise, investors in the iPath DJ-UBS Natural Gas ETN (NYSE:GAZ) felt a similar sting earlier this year.
While there has been some healthy debate over just how endangered investors are when it comes to an AMJ premium collapse — due to the fund’s size and trading liquidity — the note has traded at premiums to its NAV since JPMorgan made the decision back in mid-June.
However, not all is lost for investors looking for ETN tax efficiency for their MLP investments. There are several other choices, and for one brand-new ETN, investors won’t even notice the difference at all.
One of the beauties of the ETN structure is that they are relatively easy to launch. Unlike ETFs, which can take years to reach regulatory approval and begin trading, ETNs can go from idea to product in a matter of weeks.
Sensing an opportunity in the MLP space and with JPM’s decision to cap AMJ, Swiss investment bank UBS (NYSE:UBS) decided to launch another MLP fund in its popular ETRACS line. Rather than focusing on a different area of the MLP universe, it’s taking a direct cue from its rival.
The new ETRACS Alerian MLP Index ETN (NYSE:AMU) is essentially the same exact fund. Structured the same way and tracking the same popular Alerian Index, the ETN offers investors access to the same basket of pipeline firms, high distributions and tax efficiency, with a few bonuses — bonuses that might make it a better fund than its older rival.
First, the new ETN is open for business. This means its redemption/creation mechanism still is functioning, unlike AMJ. As the note grows in popularity — and it should given investors hunger for yield — that will allow it trade at roughly its NAV. Right now, due to its “newness,” AMU currently ended its first day costing a penny more than its daily indicative value. That’ll decrease as investors flock to the fund and trading liquidity increases.
Secondly, the new UBS MLP note charges less in expenses — AMU will charge 0.8% annually, versus AMJ’s 0.85%. That slight differential means the new UBS note will always outperform its rival by a small amount since they track exactly the same index within the ETN structure. Over the long haul, that small difference could add up to some really big returns.
Finally, ETNs are basically bonds and all have a set maturity date. For long-term investors, this maturity timeline is really something to think about. AMJ currently is set to expire on May 24, 2024. The new UBS note will be sticking around longer, lasting until 2042. When it comes to topics of estate planning and retirement, that longer timeline could be a big advantage. Especially when someone is counting on an investment to provide them a steady source of income in their golden years.
So is the new fund worth trying out? Well, it still is an ETN, so it’s not exactly perfect. However, the new AMU should catch on with investors looking to capture pipeline gold in their income portfolios.
At a bare minimum, it should help keep AMJ’s premium lower. That’ll benefit investors all around.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
Source URL: http://investorplace.com/2012/07/a-new-contender-for-your-high-yield-dollar-ubs-amu/
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