Be Wary of These 3 New MLP ETFs

It’s no secret that master limited partnerships (MLP) are hot.

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The once obscure security type has moved into to mainstream as investors have been forced to look outside the box when it comes to finding income.

Low interest rates have made traditional income sources like CD’s and Money Market funds pretty much useless in the current environment. On the other hand, MLPs — which are required to pass on much of their cash flows — are currently offering huge yields in the 5% to 9% range.

That has made them a perfect stomping ground for income seekers.

And Wall Street has answered their siren song. There are 19 different exchange-traded funds (ETFs) that track the MLP sector. So do we really need any more MLP ETFs? Well, Wall Street seems to think so, launching three new MLP ETF products.

The question now is whether or not they add anything different to the equation for investors.

A “New” Index & Non-Energy MLP Exposure

Most investor money in the MLP sector lies within just a few ETFs — $10 billion of which is in the ALPS Alerian MLP ETF (AMLP) alone. The top five funds in terms of assets track broad, well-known indexes, so recent MLP ETF launches have focused more on yield, alternative indexing or “gimmicks” to attract investors’ dollars. The recent three fund launches are no different.

First up is the Barclays OFI SteelPath MLP ETN (OSMS).

OSMS is structured as an exchange-traded note (ETN). That basically means that it’s a debt obligation of a sponsoring firm — in this case Barclays. There are advantages for funds to be structured as ETN’s as SEC regulations permit ETFs from holding more than 25% of a portfolio in MLPs. The previously mentioned AMLP is technically a corporation and gets “taxed,” causing it to underperform is index by a wide margin in boom times.

As for the underlying index that OSMS is based-off of comes courtesy of Oppenheimer and investment manager SteelPath. SteelPath is one of the more successful active managers in the MLP sector, with its mutual funds receiving pretty high grades from Morningstar. OSMS will track a benchmark of midstream-only MLPs. That means strictly pipeline, gathering and processing firms. The index will also focus on maximizing distribution growth and lowering commodity sensitivity. Current holdings include Magellan Midstream Partners (MMP) and Sunoco Logistics Partners L.P. (SXL).

Expenses for the new MLP ETF are high, but in line with many of its peer funds. Currently, OSMS charges 0.85% — or $85 per $10,000 invested — in expenses. As for maximizing distribution growth, based on its first quarterly dividend payout, OSMS yields 4.3%. That’s ot exactly in the high range of MLP funds.

Next up are a pair of ETNs issued by UBS.

The ETRACS Wells Fargo MLP Ex-Energy ETN (FMLP) takes a very different approach to the MLP sector. The fund provides exposure to the firms that use the tax structure, but aren’t in the energy industry. That includes theme park owner Cedar Fair, L.P. (FUN) and cemetery operator Stonemor Partners (STON).

It also includes a hefty dose of private equity players.

The vast majority of FMLP’s 18 holdings are buyout firms, hedge fund operators and other private equity groups. Both KKR (KKR) and Blackstone (BX) account for nearly 22% of the ETF’s holdings. That produces an interesting, but risky package of financial firms. It also produces a hefty dividend yield. FMLP underlying index yields a whopping 7.69%, which makes it one of highest yielding MLP products available.

The other launch from UBS takes that yield even further by adding dose of leverage. The ETRACS Monthly Pay 2xLeveraged Wells Fargo MLP Ex-Energy ETN (LMLP) tracks the same index, but promises to double the yield (15%) as well as the potential gains & losses.

Should You Snag These New MLP ETFs?

In the case of OSMS, I’m not sure that the fund really adds anything new to equation. While the focus on strictly midstream assets is admirable, it has already been done. The third-largest MLP ETF — the $2 billion UBS E-TRACS Alerian MLP Infrastructure ETN (MLPI) — does the same thing, with the same yield.

I’m actually more inclined to buy one of SteelPath’s actively managed MLP mutual funds rather than the ETF.

As for FMLP, the fund could be an interesting addition to a portfolio looking for some extra yield. It’s not exactly a pure-play on non-energy MLPs — the shipping firms are absent. Bu it does offer some of the cheapest exposure to the private equity space. And that yield can’t be beat. Just remember that this isn’t as safe a pipeline play.

That’s exactly why the leveraged LMLP should be avoided. Private equity firms already operate with a hefty dose of leverage, there’s no need to add any more fuel to the fire.

The Bottom Line: Skip OSMS & LMLP, nibble on FMLP if you’re feeling adventurous.

As of this writing, Aaron Levitt was long MMP.

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