One of the largest ETNs has reached its maximum weight according to the issuing institution, and will soon face restrictions on growth. JPMorgan (NYSE:JPM) announced on Monday that it would cap the maximum number of shares of the popular Alerian MLP Index ETN (NYSEARCA:AMJ) that can be issued, meaning that creations of the note could soon be halted. The cap of 129 million shares translates to a market value of about $4.7 billion. JPMorgan announced on its website that it would be issuing the remaining 11.05 million ETNs authorized for issuance on Tuesday.
The suspension of creations of new shares of exchange-traded products can lead to a premium in share prices. Because so-called Authorized Participants are not able to exchange baskets of the underlying securities for new shares in the ETN when prices rise above the NAV, there will exist the potential for a disconnect between the trading price of AMJ and the value of the underlying securities.
When the creation/redemption mechanism is working normally, such disconnects can quickly be arbitraged away, which means that the price of such ETNs will generally stay very close to the value of its component stocks. But when creations are halted, continued strong demand for the exposure offered can result in a "premium" above NAV being paid.
Perhaps the best example is the iPath DJ-UBS Natural Gas ETN (NYSEARCA:GAZ), for which iPath announced the suspension of creations in August 2009. GAZ now trades at a hefty premium to its underlying value; the recent closing price of $3.14 was about 44% above the daily indicative value of the notes. In recent months, the premium on GAZ had swelled to higher than 100%.
Investors are advised to trade carefully in exchange-traded products that have suspended issuance of new shares, since the deflation of a premium can translate into significant losses-potentially in a very short period of time. Of course, riding an inflating premium higher can also lead to meaningful (and perhaps unexpected) gains.
Alternative MLP ETFs (And ETNs)
Because there are a handful of other ETFs and ETNs that deliver substantially similar exposure as AMJ, it's possible that investors considering exposure to MLPs will simply gravitate towards one of the other options. Though it should be noted that the premium in GAZ has remained despite the availability of multiple other ETPs offering access to natural gas futures contracts.
AMJ was launched in April 2009, becoming the first exchange-traded product to specifically target MLPs. Interest in this asset class has exploded in recent years, with investors embracing MLPs as stable sources of yield in a low rate environment.
AMJ is one of nine ETPs in the MLPs ETFdb Category, meaning that investors looking to tap into this corner of the domestic energy market have a number of other options available to them. The distinction between ETFs and ETNs is, in this case, often a very important one. In addition to the considerations surrounding credit risk and tracking error, these two structures often deliver drastically different tax consequences.
There are five other MLP ETNs:
- Alerian MLP Infrastructure ETN (NYSEARCA:MLPI)
- Cushing 30 MLP Index ETN (NYSEARCA:MLPN)
- Wells Fargo MLP Index ETN (NYSEARCA:MLPW)
- Cushing MLP High Income Index ETN (NYSEARCA:MLPY)
- Alerian Natural Gas MLP Index ETN (NYSEARCA:MLPG)
There are also three ETFs offering exposure to MLPs:
- Alerian MLP ETF (NYSEARCA:AMLP)
- Yorkville High Income MLP ETF (NYSEARCA:YMLP)
- Global X MLP ETF (NYSEARCA:MLPA)
Disclosure: No positions at time of writing.
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