Hidden Private Equity ETF Promises Income

New fund FMLP backs into solid exposure to the income-oriented private equity space via MLPs.

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Senior ETF Specialist
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Reviewed by: Paul Britt
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Edited by: Paul Britt

New fund FMLP backs into solid exposure to the income-oriented private equity space via MLPs.

A new income-oriented ETF offers concentrated exposure to some of the biggest names in private equity, including KKR, Blackstone Group and Icahn Enterprises. The appeal: investing in hard-to-access private firms alongside some of the “smartest guys in the room,” and earning income along the way.

Finding the new fund isn’t easy, however. It’s called the Etracs Wells Fargo MLP Ex-Energy ETN (FMLP).

Notice the absence of any mention of private equity in the name. “MLP Ex-Energy” best describes its exposure.

MLP stands for master limited partnership, a legal structure that passes earnings through to owners without being taxed at the company level, similar to a real estate investment trust.

MLPs are hugely popular in in the ETF form, with about $20 billion total spread across 20 ETFs. (I’m using the terms “ETF” and “fund” to include ETNs—more on the wrapper in a moment.)

However, all existing MLP ETFs focus exclusively on the energy sector, typically on oil and gas infrastructure like pipelines. FMLP is unique in that it explicitly excludes energy firms, leaving it dominated by—you guessed it—private equity firms.

List Of The Listed

FMLP’s roundabout method delivers private equity exposure that stands up well next to two leading funds that take a more direct approach: PowerShares Global Listed Private Equity ETF (PSP | F-56) and the Market Vectors BDC Income ETF (BIZD | D-99).

U.S.-focused BIZD holds only business development companies (BDCs), another structure (along with MLPs) used by listed private equity firms. PSP holds both structures, and, unlike FMLP and BIZD, is global in reach.

I’ve listed top the five holdings for the three funds below.

FMLPBIZDPSP
KKR & Co LP10.9%Ares Capital Corp.15.8%Onex Corp5.9%
Blackstone Group LP10.5%American Capital Ltd.10.7%3i Group PLC4.9%
Lazard Ltd10.4%Prospect Capital Corp.9.0%Partners Group Holding AG4.9%
Carlyle Group LP10.3%Fifth Street Finance Corp.5.2%CITI KKR & CO TRS 10/31/134.4%
Icahn Enterprises LP10.3%Apollo Investment Corp.5.1%CITI Blackstone TRS 10-31-13 ASSET LG4.3%

FMLP data per issuer based on underlying index 6/20/2014. BIZD data per ETF.com as of 6/24. PSP data per issuer as of 6/24/2014.

I assume the “TRS” in PSP’s KKR and Blackstone holdings stands for “total return swap,” and that the economic exposure is similar in nature but not size to the KKR and Blackstone positions in FMLP.

The point is simply that FMLP’s “ex-energy MLP” offers private equity exposure that rivals funds specifically designed for that purpose.

Those with good knowledge of the private equity space probably have strong preferences on one portfolio over another. For the rest of us, FMLP has the appeal of taking concentrated positions in very familiar private equity names. From a more objective standpoint, PSP aligns poorly with the ETF.com benchmark for global private equity, likely due to its tiered weighting system. BIZD fits our benchmark very well for the U.S. BDCs, a subset of the larger private equity space.

 

Yield And Return

I’m loath to compare yields and returns for the fund’s underlying indexes, which is the only way to compare new FMLP with PSP and BIZD. Instead, I’ll look at the performance records of the two existing products, which differ greatly.

Fund12-Mo Yield12-Mo ReturnDistribution
PSP11.1%29.2%Quarterly
BIZD6.3%13.5%Quarterly
FMLPNewNewMonthly

Bloomberg data as of 6/24/2014. Yield based on fund distributions over past 12 months. Return based on TR NAV.

PSP’s numbers look especially great here, but the size of the cash flows is far less stable than that of BIZD.

Peer performance suggests that FMLP has the potential for high yield and positive total return. Based on the difference in holdings, I’d expect FMLP’s performance to differ materially from both peer funds here, but I can’t guess magnitude or direction. I do believe PSP and BIZD are far better reference points for FMLP than energy MLPs like the Alerian MLP (AMLP) and the ETRACS Alerian MLP Infrastructure ETN (MLPI).

Bad Wrap

I used the term “holdings” loosely above. As an exchange-traded note, FMLP doesn’t “hold” anything, at least not anything investors have claim to. Instead, FMLP is backed solely by the issuing bank’s promise to pay (UBS, in this case). The counterparty risk is minimal, in my view, and pales next to the market risk from the fund’s exposure. Note, too, that there’s a smidgeon of counterparty risk in PSP’s swap exposure.

FMLP’s ETN wrapper allows it to take the concentrated positions noted above without fear of bumping into diversification rules that govern “true” ETFs like PSP and BIZD.

Income is a huge part of the draw to this space, and FMLP loses a step next to BIZD and PSP in that its distributions are taxed as ordinary income rather than qualified dividends. That’s an apples-to-oranges comparison, since distributions from “true” ETFs that hold MLPs are treated as a return of capital. See our MLP guide for a lot more info on taxes.

FMLP has the edge on headline fees, however, charging 0.85 percent. PSP charges 2.19 percent and BIZD an almost unbelievable 8.33 percent. However, PSP and BIZD report the expenses of the underlying companies as “acquired fees.” All underling entities have expenses that will flow through to the end investor’s bottom line, but for BIZD and PSP, these are reported in the expense ratio.

In short, FMLP is worth a look from income-oriented investors, especially those willing to consider a narrow space like private equity. The fund could also work as a diversifier in an equity-income portfolio that already holds energy MLP and REIT exposure. Trade the new fund with care and do some homework on taxes from MLPs in fund structures before jumping in.

Footnote—other private equity ETFs: Etracs Wells Fargo Business Company ETN (BDCS | F-8), ProShares Global Listed Private Equity (PEX | F-49), and a newly launched 2x version of FMLP, Etracs Monthly Pay 2xLeveraged Wells Fargo MLP Ex-Energy ETN (LMLP).


At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.

 

Paul Britt, CFA, is a senior analyst in the ETF Analytics group at FactSet, a team that maintains and develops an industry-leading suite of ETF-related data and analytics products. Prior to joining FactSet in April 2015, he was a senior analyst at etf.com, where he performed a similar role, and worked in private placement at Pensco Trust. Paul holds a B.S. from RIT and an M.S. in financial analysis from the University of San Francisco.