About one month ago (on May 17th, 2016 to be precise), Credit Suisse launched the Credit Suisse X-Links Monthly Pay 2xLeveraged Alerian MLP Index ETN (NYSEARCA:AMJL) under their "X-links" suite of ETNs. AMJL tracks twice the monthly return of the Alerian MLP Index, and pays a variable monthly coupon linked to the net cash distributions of the index constituents. The maturity date of the note is May 16th, 2036.
How does this ETN compare to UBS' similar sounding ETRACS 2xMonthly Leveraged Alerian MLP Infrastructure Index ETN Series B (NYSEARCA:MLPQ)? (which readers may recall was launched to replace the well known but now-defunct ETRACS 2x Leveraged Long Alerian MLP Infrastructure Index ETN (NYSEARCA:MLPL))
1. Different index
The main difference between the two funds is that they track different indices. AMJL tracks the Alerian MLP Index [AMZ], whereas MLPQ tracks the Alerian MLP Infrastructure Index [AMZI]. As the above links will reveal, the two indices are very similar. As of time of writing, 9 of the top 10 constituents of the two funds are shared. AMZ currently has an index yield of 7.39% while AMZI's is slightly higher, at 7.46%. AMZ also has a much greater weighting in the top MLP Enterprise Product Partners (NYSE:EPD) at 19.9%, compared to 11.7% for AMZI.
The most well-known fund that tracks AMZ is the JPMorgan Alerian MLP Index ETN (NYSEARCA:AMJ), while for AMZI it is the Alerian MLP ETF (NYSEARCA:AMLP). Both are multibillion dollar funds. However, because an ETF is encumbered by tax issues (such as deferred tax liabilities when MLPs appreciate) while an ETN, which is essentially a debt instrument, is not, a head to head comparison of the total return performance of AMJ and AMLP would not be appropriate. Instead, we can compare the performance of AMJ with ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA:MLPI), an unleveraged ETN that tracks AMZI. We can see from the graph below that over the past five years, the two funds have moved pretty much in lockstep, with MLPI (tracking AMZI) slightly outperforming AMJ (tracking AMZ) over this time period.
Obviously, it goes without saying that an investor interested in obtaining 2x leveraged exposure to MLPs but who prefers AMZ over AMZI should buy AMJL, while he who prefers AMZI over AMZ should purchase MLPQ, all other things being equal.
2. Same leverage reset trigger
As explained in "MLPQ Reborn?", UBS introduced a new "Loss Rebalancing Event" with the newly launched MLPQ that was not present for MLPL in order to prevent the catastrophic losses that we saw for the latter fund during the MLP crisis earlier this year. With MLPL, consistent losses were magnified due to the requirement of the fund to track twice the monthly return of the index, and when the index dropped by 30%, the fund was mandatorily closed.
With MLPQ, the loss rebalancing event is triggered when the underlying index declines 20% (i.e. corresponding to a 40% decline in MLPQ) from the previous month's close (or the previous reset level, since the event can be triggered multiple times in a month). When this happens, the leverage of the fund is reset to 2. This prevents further losses from that point onwards from being magnified (with leverage factor greater than 2).
By looking at AMJL's prospectus, we see that Credit Suisse employs a very similar rule. Instead of being called a "Loss Rebalancing Event", AMJL's is termed a "Leverage Reset Event". However, the net effect is the same:
A "Leverage Reset Event" occurs if, on any Trading Day (other than an Excluded Day, as defined herein), the Index Closing Level is equal to or less than 80% of the Index Closing Level on the most recent Reset Valuation Date. If a Leverage Reset Event occurs, the Current Principal Amount of the ETNs will be reset as described below, which will have the effect of deleveraging the ETNs with the aim of resetting the then-current leverage to approximately 2.0.
3. Same acceleration trigger
Both funds have the same acceleration trigger: if the indicative value of the fund closes below $5, the funds will be redeemed. As AMJL currently trades at about $28 whereas MLPQ trades at $55, this would suggest that AMJL would be the first to be mandatorily redeemed should MLPs sink.
Furthermore, both funds lack the acceleration condition that shuttered MLPL: a decline of 30% in the underlying index during the month.
4. Same fee structure
Both funds have identical fee structures: a "tracking rate" of 0.85%, and a financing spread of 0.80%, which is added to 3-month libor to calculate the total financing charge. The total expense ratio is thus 1.65% + 3-month libor.
I've written before that I lament this obfuscation of management fees. I understand that a financing charge is necessary, but why hide the additional 0.80% of fees in the financing spread (which for MLPQ is displayed only in the prospectus and not the fund website) rather than simply adding it to the tracking rate so that investors would have a better idea of the total expense ratio?
Partial credit goes to Credit Suisse (no pun intended), who display both the tracking rate and the financing spread on AMJL's website.
The newly launched AMLJ, which tracks the Alerian MLP Index [AMZ], shares a number of characteristics with the fellow 2x leveraged MLPQ, linked to the Alerian MLP Infrastructure Index [AMZI]. Both have the same fee structures, and leverage reset and acceleration mechanisms. Additionally, unlike most leveraged funds on the market, both AMLJ and MLPQ reset their leverage monthly rather than daily, which should reduce leverage decay.
Investors who wish to obtain 2x leveraged exposure to MLPs could do well with either AMLJ or MLPQ, or even the UBS ETRACS 2xMonthly Leveraged S&P MLP Index ETN Series B (NYSEARCA:MLPZ), which tracks a different MLP index: the S&P MLP Index. Of course, investors in these ETNs should be aware that these are essential debt instruments and thus their value is dependent upon the solvency of the issuer, in this case either UBS (NYSE:UBS) or Credit Suisse (NYSE:CS), meaning that ETN investors additionally bear counterparty risk over ETF investors.
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Disclosure: I am/we are long MLPQ.
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