This is the second article in the series of getting REIT and MLP returns in one's tax protected account while avoiding the IRS mandated $1000.00 taxation limit. The first article reviewed the Neuberger Berman Real Estate Securities Income Fund (NRO), a closed end fund that offered 7% ordinary dividends from a managed account of REITs. This article covers 2 ETNs that offer the returns one can get from MLPs; UBS ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA:MLPI) and UBS ETRAC 2x Leveraged Long Alerian MLP Infrastructure Index ETN (NYSEARCA:MLPL).
Before moving into the fund analyses, let's consider what composes the Alerian MLP Index. The index is composed of large and mid-cap energy Master Limited Partnerships that is adjusted by float and capitalization. It includes 50 MLPs and represents about 75% of available market capitalization of the industry. Returns are disseminated on a real time basis on price return (AMZ) and on a total return (AMZI) basis.
A complete list of the Alerian index components is listed below:
Source: Alerian.Com Fact Sheet
Knowing the composition of the index allows one to know what the 2 ETNs listed above is designed to follow. ETNs are not the same as an ETF in that an ETF owns the assets it is created to cover where an ETN probably does not. ETN stands for Exchange Traded Note which means that the issuing bank or investment house is issuing a note that follows the list of assets it purports to cover. The ETN may or may not own the assets and therefore the owner of the ETN is dependent upon the underwriter to fulfill the obligations of the issue. If the underwriter goes bankrupt, the owner of the ETN risks total default. So one must be sure that underwriter's credit rating is worthy. If the underwriter were to receive a credit downgrade, the shares of the ETN would also experience a downturn independent of the underlying asset. The advantage of an ETN over the ETF is that the ETN follows the asset exactly while ETF only comes close because of the costs of trading and administering the assets.
Since UBS AG (NYSE:UBS) underwrites these 2 ETNs and has a strong credit rating with an A rating from all the major rating agencies with over $1 trillion in assets, these ETNs should only move with the Alerian Index. Therefore the issue to consider revolves around the assets themselves and not the underwriter since this Swiss investment bank appears to be sound. Whatever returns the Alerian Index offers, the 2 ETNs listed above will offer as well with 1 major difference; MLPI will return exactly what the index returns, but MLPL will triple what the index returns.
MLPI currently offers a yield of nearly 5% and sells for around $38.00 per share. MLPL offers a yield of nearly 12% because of the 2 times leverage and sells for around $49.00 per share. Below are 3 charts to compare the prices of Alerian Index, MLPI and MLPL:
The Alerian Index from 5/29/14 to 5/29/15
MLPI from June 4, 2014 to June4, 2015
Source: Interactive Brokers
MLPL from June 4, 2014 to June 4, 2015
Source: Interactive Brokers
Comparing the 3 graphs demonstrates that the price patterns for all three charts are fairly similar. The major difference can be seen in the bottom chart where the price differentials are much larger than that of the second graph because of leverage. The 2 times leverage of MLPL causes the ETN price to move up or down 3 times what MLPI does as well as offering 3 times the dividend. For example, while I am writing this article MLPI is down $0.39 and MLPL is down $1.19. So if you want 3 times the yield, you must also be willing to take 3 times the risk.
Since ETNs are notes, the IRS is currently allowing these 2 ETNs to be considered acceptable returns in an IRA. That is, the dividends are not counted as returns from MLPs that would incur the $1000.00 limit for taxation in an IRA. If you are reasonably sure that the stock price of MLPs is about to rise over the next 12 months, then place your MLP industry money in MLPL to get a strong return. If you are unsure about the direction of MLPs over the next 12 months and desire to reap an MLP yield, you can invest in MLPI. However my choice for an IRA investment in MLPs is currently the InfraCap MLP ETF (AMZA). AMZA uses less leverage than MLPL and does not have as much price movement. It is a managed ETF instead of blindly following the Alerian Index. This allows AMZA to move into the pipeline segment of the industry while exploration is not doing well because of the low price of oil and gas. You can find my earlier analyses of AMZA here and here.
Disclosure: The author is long MLPL.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.