A Closer Look at Energy Infrastructure CEFs, ETN

The Bear Stearns Alerian MLP Select ETN (BSR) modified its name. It's now called BearLinx Alerian MLP Select ETN, so that investors may not associate the exchange-traded note with the Bear Stearns buyout last year.

Nevertheless, the investment still tracks the performance of 50 Master Limited Partnerships in the Alerian Select Index. The objective is to provide investors with a means to access the expansive energy MLP universe. And it currently yields about 6.5%.

Still, why would someone want to consider an exchange-traded note that carries the risk of default by the issuer? Isn't this associated with the failed Bear Stearns institution?

Yes... and no. Bear Stearns is now a division of J.P. Morgan. So technically speaking, the original issuer, Bear Stearns, did not go under. It just sold for a few rubles to JPMorgan Chase.

Moreover, the net asset value and actual share price of BSR have been pretty close throughout the past year. This would suggest that the market is not concerned with the debt of the issuer, whether it's that of a subsidiary called Bear Stearns or the larger JPMorgan Chase.

That said, I can't in good conscience consider this exchange-traded note, even though I am very fond of the energy Master Limited Partnership space. Instead, I think that energy infrastructure investors can look to the close cousin of ETFs/ETNs... the closed-end fund (CEF).

By way of review, infrastructure MLPs own/operate long-standing physical assets that transport or store natural resources. The pipeline industry isn't going anywhere, and many of the biggest players from Enbridge to Kinder Morgan to TransCanada (TRP) are investing heavily in maintaining their territories.

At the moment, many individual MLPs are offering double-digit, 10%+ yields, including Enbridge Energy Partners LP (EEP), Kinder Morgan Energy Partners LP (KMP) and Energy Transfer Partners LP (ETP). Of course, investing in an individual MLP may not achieve as much diversification as one might like.

So that brings us to the discussion of CEFs like the Fiduciary Claymore MLP Opportunity Fund (FMO). It has a current distribution rate of roughly 12%, and is diversified clear across most of the big MLP names like the 3 listed above. (Note: The big drawback here is the possibility that fund management fees may siphon off 3% of the distribution yield.)

Another CEF possibility is the Tortoise Energy Infrastructure Fund (TYG). The fees are much smaller than some MLP aggregators. Its dividend yield is 10.5%. Its one drawback, depending upon how one views leverage, is the fact that it does use leverage!

With 10-year treasury bonds offering 2.75%, and diversified MLP baskets offering 6.5%-12%, that's a pretty significant yield spread. Historically, when the yield spread between MLPs and treasuries are greater than 3%, it's served as a pretty strong buying opportunity.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[Mitch Tuchman:]

Gary -- I could never get comfortable with buying an ETN for owning MLPs because MLPs have so much variation. I like ETFs for asset class investing. What I did, was built my own basket of mid-stream MLPs and have owned the top 10 in terms of market cap for over a year. While my "index" is down about 20%, I'm getting an average of 10% return and have very little exposure to the price of energy since I own MLPs that are paid for the amount of oil and gas that runs their their pipelines. The other thing about MLPs, is that you should plan on owning them for a long time in a taxable account. The returns come to you on a K1 and are classified largely as a "return of capital" so there are no immediate taxes due. However, sell the MLP, and you'll have to recapture all of that at some point. So if you're going to own them, make a long term commitment and enjoy the ride. Also plan on spending a few extra $ with your accountant entering all the K1s into your tax return.

Mar 19 10:14 AM

[SamuelB:]

TYG has a 6+% cost for use of leverage.
Not sure why you would not just buy the MLPs. I realize you are getting diversification with TYG, but their cost of borrowing is fairly high.

Mar 19 12:55 PM

[Dheilner:]

Could you comment on KYE and the thorny issue with Taxation and MLPs

Mar 19 12:57 PM

[Alan Young:]

Both FMO and TYG are trading at considerable premiums (15%, 11%) . If you know a good reason to pay such a premium, please say so. Another CEF, MTP, will get you the same assets at closer to NAV (2% premium)-- and therefore less downside risk if market sentiment changes.

I agree that it's undesireable to hold ETNs, due to the counterparty risk.

Mar 20 01:25 AM

[rcprofit:]

Take a look at ticker BIP, it is a spin off of BAM. BIP is an infrastructure play... Very volitile...

- I don't own the position.

Mar 20 08:34 AM

[prairiedog555:]

I just did my tax's. I have 2 MLPs, ETP and KMP. I went to the Kinder morgan website to access the K1 info. It was very easy and when I got there there was a link to access many other MLPs (there is a service that does this) to retrieve the K1 info and this service has a function to export info to Turbo tax as well.
When I get my K1 info to my CPA the xtra cost is negligable.

Mar 20 08:37 AM

[La Marque:]

I won't buy into ETNs or MLPs. ETNs have too much risk. MLPs are just taxable headaches. You may also be subject to various states' non-resident income taxes. CEFs such as FMO and TYG are easier on taxes because they pay the taxes everywhere and you get return of capital and qualified dividends.

Mar 20 09:54 AM

[Geoffrey Lordi:]

According to ETFConnect, TYG didn't pay a distribution on 2/19/2009 - the first time (using ETFC's data) that there wasn't a payout for 11 quarters...Of course, it could be just ETFC, as well: according to them, there's also no data for sector/holdings summary (very odd for ETFC).

Mar 20 10:11 AM

[tinman:]

Even scarier, CEFA says FMO & TYG have no income (zip, nada!) to distribute so the "yield" is all return of capital!

Mar 20 08:48 PM

[Delojozafado:]

MTP trades at on of the most favorable discount/premium usually a discount. KYE is perhaps a best in class but only as to it's diversification into other asset classes as CanRoy trusts. KYE's commitment and ability to sustain it's dividend with out large cuts is partly reflected in the premium. A re-tracement to say 50% of it's 104 week high might be a reason to pay up and sit on the 13% distribution.KYE just went ex 4/1 and in fact did modestly reduce the payout from 52 to 48 cents. Not exactly falling off the cliff. Still I recently off loaded some shares at $15.09 last week in the pre ex hysteria move to $15.40 from the previous day's $14.40. I would retake that position with some additional shares if the market continues to create the kind of volatility that took this CEF down to $10.10 a few weeks ago. BSR, MTP, & KYE are all excellent trading vehicles in this kind of market. God forbid you make a miss calculation and buy a KYE at $12.50 and it then goes to $11.00. You may have to sit on that dividend awaiting the next upper range resistance level to sell a partial.

Apr 02 08:05 AM

[sf123:]

FMO and TYG are leveraged. That means more risky than BSR, which is an ETN. BSR is a good idea for investor who wants to own all the major midstream MLPs. The downside is that there are a lot of small positions in smaller (and may be risker) MLPs. But with FMO, TYG and BSR, you don't have to deal with K-1.

Apr 02 11:04 PM