Midstream MLP Funds Faring Better

October 07, 2015

[This article originally appeared in our October issue of ETF Report.]

Jay Jacobs is a research analyst at Global X, a New York-based sponsor of ETFs, with $3.7 billion in managed assets invested in 40 funds available across U.S. and foreign exchanges. Jacobs oversees the firm’s research team and helped establish GlobalXResearch.com, a website featuring original content and curated third-party news and research.

Global X has three master limited partnership ETFs: the pure-play MLP fund, Global X MLP (MLPA), which is down 22.4% as of Aug. 25; the regulated investment companies-structured Global X MLP & Energy Infrastructure (MLPX), down 20.23%; and the Global X Junior MLP (MLPJ), which is down 39.4%. MLPA is the largest of the three funds, with nearly $150 million in assets under management.

MLPA tracks the Solactive MLP Infrastructure Index. Would you describe the index?
It’s an index of the largest MLPs in the midstream sector in the U.S.

Since MLPA is structured as a C-corporation, how do the tax implications affect performance?
On a daily basis, the fund has to accrue a tax liability based on essentially the realized and unrealized gains of the fund. In an up market, the fund will tend to trail the index, because it’s accruing taxes on the way up. In a down market, the fund, in some environments, will lag the index, because it can offset some of the falling with the tax liability. At the end of the year, [the tax liability is] shown as an expense on the prospectus.

Let’s talk about fees and how the fund is performing.
We have a 45 bp management fee, and then there are the tax expenses, which change year to year. It’s difficult to know what that tax expense will be in any given year [as it depends on the fund’s return]. At 45 bps, if my recent research is correct, we are the lowest-management-fee MLP ETF out there. The only other 45 bp management-fee MLP ETF is our MLPX ETF.

I think one of the key reasons this fund has held up better than other MLP funds is because of its midstream exposure. Some other funds may be more focused on the yield characteristics of MLPs, or they’re more broadly trying to access the entire MLP market—regardless of upstream, midstream or downstream.

Our fund is laser-focused on midstream MLPs. What that means is we’re only focused on MLPs involved in the storage, transportation and processing of oil and natural gas. Those businesses tend to be more insulated from the price of oil.

Because they’re in a toll-road business model, they’re paid on the amount of oil or natural gas they’re transporting through pipelines rather than the value of the underlying commodities. You could compare that to upstream, where you’re basically drilling.

If you’re drilling and extracting oil from the ground, you’re selling it at the market price of oil. Those drillers have a high sensitivity to oil prices. Midstream is just taking oil from point A to point B.

What is pressuring the MLP market? Is it weak oil prices, concerns about global growth, a possible Federal Reserve rate hike?
It’s a little bit of everything. It does seem like the MLP market has been trading in line with some other energy stocks, which is pretty surprising to us. We think that the MLP business model is much more robust than other energy stocks. It’s created a situation where the valuations on MLPs are actually quite attractive relative to where they’ve historically been.

Different valuation metrics don’t always make sense for different businesses. One of the measures I like for MLPs in this environment is EV to EBITDA [enterprise value to earnings before interest, taxes, depreciation and amortization]. If you look at EV to EBITDA, valuations are at their most attractive point since mid-2011.

What does this pressure mean for the sector?
I think it depends on how an investor is looking at MLPs. We tend to see two types of investors. We see the asset allocators who look at MLPs as an asset class, and when we talk to those clients, they tend to still like the MLP vehicle. If you see MLPs as an asset class, then the recent volatility shouldn’t bother you, because inherently MLPs are still are what they are: They still tend to have low correlations to equities; they tend to be yield-based instruments. Because of that, they tend to still be a different asset class that serves a specific purpose in their portfolio.

When we look at the other types of investors who might look at MLPs as a tactical opportunity, that’s when it runs the spectrum and you see bunch of different opinions. Some people are coming in and are very bullish on the MLP sector, they’re bullish on energy, they’re looking for different ways to play it; they’re buying for a pure tactical allocation. We tend to be more on the asset allocation side.

In the MLP space, there has been a lot of merger and acquisition activity. What does this say to you?
That’s definitely a good signal. At the end of the day, it tends to be a smaller industry than the whole market. It’s a subindustry; it’s a pocket of the market. And the people buying and selling MLPs are in that subindustry. They’re the insiders, they know the market, they have the most information. So if you see more M&A in the space, that’s an indication they’re bullish on the space.

When advisors talk to you about the space, what are they asking?
It really depends on their time frame. When advisors are calling and asking about the MLP space, they tend to be looking more short term; when they’re calling and asking more generally about the fund and a little less concerned, they tend to take a more medium- and long-term view. Some are nervous about the recent pullback, but the asset allocators are looking more for long-term opportunity.

We’re seeing some oil rig counts falling, the growth in fracking is slowing down. If we see oil prices fall and if we see the volume of oil produced falling, how does that impact midstream producers?
It can vary by MLP. Some of the drillers, the oil producers, sign very-long-term contracts with MLPs, so they locked in a specific price to transport the commodity from point A to point B. In some instances, they’ve pre-leased space in that pipeline or in that storage facility. So in those instances, it doesn’t matter how much they’re producing for the MLP. For others, it can be more variable. So if we see more drillers coming offline, less oil coming off, that can slow down the growth of the MLP space, but again, MLPs are designed to be insulated from the price movement.

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