What To Do About MLPs After Turmoil

Kenny Feng is president and CEO of Alerian, a leading provider of MLP indexes. About $18 billion is tied to the Alerian Index Series, including the $9.5 billion Alerian MLP ETF (AMLP) and the $3.1 billion J.P. Morgan Alerian MLP ETN (AMJ). ETF.com spoke with Feng to discuss the latest outlook for MLPs after recent share price declines, and what the Republican tax cuts mean for MLP ETFs.

ETF.com: MLPs recently hit two-year lows. Do you think this is a buying opportunity?

Kenny Feng: We generally don't get in on the argument of whether or not it's a good buying opportunity, but I can tell you both sides of the story.

The people who say it’s a buying opportunity tend to focus very heavily on the fundamentals. They argue that the fundamentals and the story are great. Long term, MLPs are a bet on North American energy infrastructure and on non-OECD Asia GDP growth.

But while that may be true, and I wouldn’t dissuade anybody from focusing on fundamentals—in an ideal world, the market action reflects fundamentals—right now, the technical factors are where investors are much more focused.

The people who are short, or the people who are still concerned, are very focused on the technical aspects of how the capital markets work—behavioral finance type of issues.

For those people, MLPs haven’t done what they’re supposed to do. As far as they’re concerned, MLPs were supposed to pay a stable and growing distribution; be largely agnostic to commodity prices; and have business models that were supposed to be fee-based in nature. But in many cases, these companies have shown themselves not to fit those criteria.

Now there’s this debate over what the 2.0 version of MLPs is supposed to be. You have some companies following a self-funding model; you have others retaining their cash flow because the market isn’t rewarding distribution growth; others cutting their distributions dramatically; and others continuing to do things how they’ve done them historically.

There are all these different kinds of models, but there isn't one dominant model at this moment, so there's uncertainty about how each company's going to pursue its route going forward. That’s created uncertainty, and uncertainty is the enemy of premium valuations.

People are also tired. It's been several quarters now where at least one large- or a midcap MLP has effectively cut its distribution, either directly or through a backdoor cut. Each time that happens, people are saying, “Who’s next?”

If the whole industry just slashed its distribution in one particular quarter, you'd actually get better traction than you have now. It's just the fact that there's always this "what’s next” uncertainty that’s part of the issue.

To me, the best thing that could happen for MLPs is two quarters of nothing happening—no distribution cuts, no companies having this issue or that issue, no oil price plunge and no big interest rate movements.

ETF.com: Is it more appealing for investors to buy MLPs in the ETF wrapper after the tax cuts?

Feng: You have a smaller percentage that's being taken from net asset value in the form of a deferred tax liability. In a vacuum, that’s positive for the MLP ETFs and any ’40 Act fund—including mutual funds and closed-end funds—that owns more than 25% of its fund assets in K-1 issuers.

That said, we still continue to believe that a U.S. taxable investor who doesn’t mind processing their own K-1s, or who has an accountant who can, and is comfortable with single-security risk or building their own portfolio, is going to be better off owning MLPs directly. We've said that a million times since the beginning.

For everyone else who doesn't fall into all those categories, there are products that attempt to meet their investment objective. In today’s public markets, there are seven of those types.

There are ETNs, there’s both the C-corp and RIC version of ETFs, same for closed-end funds and open-ended mutual funds. Each investor or advisor has to make the best decision based on what their investment objectives are and what their projected return is for the space overall.

Contact Sumit Roy at [email protected]