Advisor Views On MLP Funds & Notes

November 11, 2014

Straddling fixed income and energy growth is attractive.

[See our upcoming December edition of ETF Report for a special MLP supplement.]

Erman Civelek, CFA

Senior Vice President, Investment Strategist

The MDE Group

Morristown, N.J.

AUM: $1.3 Billion

 

How does your firm use MLP ETFs and allocations?

We use it as what we call a hybrid asset class spanning income and growth. Traditionally, investors have chosen equities to give them long-term growth. MLPs fall right in between those two. We have a bucket in our risk models in which it is right between equities and fixed income. Within that bucket, we’re looking at MLPs to provide both income and growth elements in our portfolios.

The income is pretty attractive. You’re starting the year with 5-6% type income, and then on top of that, you’re looking to add midsingle digits, growth opportunities. Obviously it doesn’t come in a linear fashion. Some years you lose money, some years you make more than your expected return.

Maybe you just answered my second question, which is, do you treat MLP funds as a fixed-income play or an energy play, or both?

We use it as one of the fixed-income alternatives, but we don’t categorize it as fixed income because it doesn’t have a fixed income. What we’re looking to do is really more thematic, which is to take advantage of the energy infrastructure buildup in United States. We’re looking to invest in companies that build, acquire and operate these transportation assets. We focus on the midstream partnership space that acts as a fee-based, toll-road-type business, where its revenues are indexed inflation, and they look to grow with inflation.

What particular ETFs or ETNs do you use?

We’ve used multiple vehicles over years. And it really depends on whether the investor wants to take credit risk, leverage risk or the burden of extensive K-1 reporting. The cleanest and the most client-friendly format is the ETF format, which gives you no credit risk and it gives you daily liquidity, no leverage, low fees. But you’re paying a price for double taxation, because the companies that have more than 25% in MLPs have to withhold taxes. And that creates a drag on performance in up markets.

For ETFs, we use the Alerian MLP (AMLP). And in terms of the next bucket, which would be the exchange-traded note, we use Etracs Alerian MLP Infrastructure ETN (MLPI). With ETNs, you take a credit risk of those institutions, you’re a line item on their balance sheet as a borrower, so you’re really holding a credit instrument. But also, you get ordinary tax rates because you’re holding a bond. We found those two elements less appealing, so we really haven’t done too much investing in the ETN space because of the investment committee’s goal of not introducing credit risk into the equation.

What’s the tax difference between an ETN and ETF?

With an ETN, you’re holding a note that’s issued by a large bank. And the return on that would be taxed at the ordinary tax rate, whereas with an ETF, it’s tax advantaged. Most of your return is deferred in terms of capital, so it would qualify as a tax advantage.

 

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