InfraCap MLP ETF's (NYSE: AMZA) high expense ratio, risky investment and trading strategies, sustained history of underperformance, and unsustainable dividend make it one of the worst MLP ETFs in the market today.
Fund Overview: Expensive and Inefficient Structure
AMZA is an ETF, administered by Virtus Investment Partners, focusing on MLPs, and MLPs' general partners. Three key things stand out about the fund itself:
- It is actively-managed, so shareholder returns are dependent on the fund's management team and its investment strategy, their success is not guaranteed.
- It is leveraged, potential shareholder returns and losses, and overall investor risk and volatility, are all magnified. Leverage currently stands at 25% of managed assets, with costs of 0.98%, both of managed assets.
- It is structured as a corporation, so the fund has to pay corporate income tax. Although this is a negative, in practice, taxes are basically non-existent due to the favorable tax treatment of MLP distributions.
Due to the above, AMZA is one of the most expensive MLP ETFs in the market, and also one of the few forced to pay corporate income taxes:
(Source: Company Filings - Chart by Author)
AMZA's relatively high expense ratio and inefficient tax structure are both negatives to its investors. Although the fund's active management and use of leverage aren't necessarily bad, they do make for a relatively risky and volatile fund.
AMZA invests the vast majority of its assets in MLPs, although the fund also has sizable holdings in some MLP General Partners, energy infrastructure corporations, and in energy-related companies (refineries, oil producers, etc.). AMZA's holdings as of last quarter:
(Source: AMZA Factsheet)
As you can see, most holdings are MLPs, Phillips 66 (NYSE:PSX) and Williams Cos. (NYSE:WMB) are midstream corporations, while Marathon Petroleum Corp. (NYSE:MPC) is an oil refiner. AMZA is a bit more diversified than most of its peers, most of which invest exclusively in MLPs:
(Source: Company Filings - Chart by Author)
Investment Strategy: Overly Complicated and Risky
AMZA's overall investment strategy is significantly more complicated and risky that of most MLP ETFs for the following reasons: it is actively managed, it uses derivatives, it engages in short-selling, and it engages in commodity price speculation. Some funds are able to successfully manage and execute the above strategies, trades and investments. I don't believe AMZA to be one such fund.
Pretty self-explanatory. AMZA's managers decide in which holdings to invest and their weights, decisions which heavily impact total shareholder returns. Although there is nothing inherently wrong with this approach, broad-based index funds are almost always far simpler, more diversified, and less risky. AMZA, specifically, seems to invest, trade and speculate in particularly reckless way, as we'll soon see.
AMZA engages in derivatives trading, buying and selling call and put options. This is relatively rare for ETFs, although much more common for other types of investment funds, including CEFs. Some funds have very clear-cut, straightforward, derivatives trading strategies, such as selling covered call options to increase distributions. From what I've seen and read, this is not the case for AMZA.
Derivatives trading is, in itself, somewhat risky, shareholder returns are partly dependent on AMZA's investment managers identifying, implementing, and executing their options strategies successfully. As AMZA doesn't seem to haven an overarching derivatives strategy, it is difficult for me to evaluate their derivatives trading. Nevertheless, I haven't liked what I've seen.
AMZA recently had one large derivatives trade, a bull put spread on the S&P 500 (SPY). The trade amounted to about 2.3% of AMZA's total assets, and 95% of its derivatives positions. The options themselves:
(Source: AMZA Corporate Website)
It's a complicated trade, especially so considering I'm not certain when the options were written/bought. In general terms, the trade will be profitable if the SPY ends higher than $267 on the 12/21/18, unprofitable if it ends lower than $260, unclear if it ends up somewhere in that range. It is possible (likely?) that the trade was a bullish call on the Federal Reserve meeting on 12/19/2018. The Fed raised interest rates, Wall Street freaked out, the stock market tumbled a bit, and the SPY closed at $240. AMZA's latest derivatives trade wasn't even close to be profitable:
Its just one trade, but I don't like it, nor like what it says about AMZA's investment strategy. Trading SPY options on the week of a Federal Reserve meeting is basically gambling. A bull put spread in the middle of a market downturn seems almost designed to maximize volatility and risk. I'm not sure that most responsible funds, least of all an MLP ETF, should be doing these types of trades and taking these types of risks. If you are going to do them, at least get them right, no one should be paying AMZA 1.93% in annual fees for the privilege of losing their money.
AMZA's use of derivatives makes it significantly riskier than most of its peers, and exposes its investors to losses due to bad trades and calls, such as AMZA's most recent bull put spread.
Short-Selling and Commodity Price Speculation
AMZA also engages in short-selling of stocks and funds, something that is relatively rare for MLP ETFs and funds. AMZA's shorts, unlike its derivatives, do follow a relatively clear-cut, and unsuccessful, strategy.
First, AMZA is generally short the iShares 20+ Year Treasury Bond ETF (NYSE: TLT) as a hedge against rising long-term interest rates. As the fund uses some leverage, and MLPs and energy infrastructure are very capital-intensive, these short positions should, in theory, reduce investor risk and volatility.
AMZA has increased its TLT shorts since April, and they have performed quite badly since about October:
Second, AMZA is usually short The United States Natural Gas ETF (NYSE: UNG) and The United States Oil ETF, LP (NYSE: USO), which, in effect, means the fund is short natural gas and oil prices. As most MLPs are correlated with oil and natural gas prices, this serves to limit the fund's downside a bit:
Nevertheless, from what I've seen and read, AMZA's short positions have mostly led to sizable investor losses. The fund lost about $16 million in the first half of the year through short-selling, equivalent to a -5% annualized loss. As AMZA also had sizable investment losses, short-selling not only failed in reducing investor losses, it actually managed to amplify these:
(Source: AMZA Semi-Annual Report)
AMZA recently closed its oil and natural gas short positions, for reasons unclear. Considering how commodity prices have moved in the past few months, it seems like it was the right move, but it depends on when exactly the positions were closed:
Now, I'm not incredibly risk-averse. I don't believe that options trading and derivatives are intrinsically bad, but they do make for a relatively risky, volatile, and uncertain fund, and one that is much more dependent on its management team. AMZA's trades have been unsuccessful and unprofitable, investors are taking a lot of extra risk for little in return.
Shareholder Returns: Disastrous and Underperforming
AMZA's failed investment strategy has led to disastrous shareholder losses for years. Total shareholder returns have been disastrous in all relevant time frames, and the fund has significantly underperformed its larger peers since inception. It is likely to be one of the worst, if not the worst, MLP fund since inception in the entire market.
AMZA's shareholders have seen most of their capital wiped out since the fund's inception, distributions have barely covered a small portion of their losses:
Losses are accelerating, AMZA lost a third of its value in the past three months, about twice as much as the broader market:
If AMZA keeps performing like it has in the past, investors will likely be completely wiped out in the coming years.
Although most MLPs have performed quite badly in the recent past, AMZA is in a league of its own. AMZA has underperformed its peers by 9% annually, on average, since inception, no fund comes close to AMZA's losses throughout the years:
(Source: Ycharts - Chart by Author)
AMZA also compares unfavorably to the average CEF. Although these funds are structured differently, they are generally actively managed, use leverage and derivatives, so they are much more similar to AMZA in most regards:
(Source: Cefconnect.com - Chart by Author)
AMZA's disastrous performance throughout the years is, in my opinion, indicative of the fund's subpar investment strategy. CEFs have, mostly, managed to outperform ETFs due to their use of risk-reducing derivatives strategies and yield-enhancing leverage. AMZA's attempts at the same have only resulted in significantly greater shareholder losses. Although past performance is not a guarantee of future results, I believe AMZA's managers have proven themselves incapable of successfully managing their fund. I don't expect them to improve.
Distribution: Deceptive, Not Covered, Suckers Yield
AMZA's distribution yield of 25.50% is staggering, and significantly greater than that of its ETF peers:
(Source: Ycharts - Chart by Author)
AMZA's distribution yield is also much higher than that of most CEFs which have an average distribution yield of about 13%, according to Cefconnect.com.
It's an eye-catching yield, and irresistible to many income investors and retirees, but it barely matters at all. AMZA's yield doesn't change the fact that total shareholder returns have averaged -17.4% since inception; the fund has never generated enough in income/returns to sustain its yield. The distribution is mostly a destructive return of capital (ROC) distribution, AMZA isn't even close to covering it. Now, technically, distributions from most MLPs and MLP funds are classified as ROC due to certain favorable tax treatments. AMZA's distribution would most likely be ROC regardless of the fund's underlying performance and income generation. By destructive ROC distribution I mean the fund's distribution isn't being covered, and the fund is just returning to shareholders their own capital.
It should be obvious to readers and investors that AMZA can't plausibly cover such a high yield. 25.50% is about what the best investment managers in history have attained throughout the years, getting that solely through dividends and distributions is functionally impossible. Most MLPs yield somewhere between 6% and 15%, significantly less than what AMZA is yielding. You can't bridge that gap with a bit of leverage and some option trades, the math just isn't there.
Now, there are many ways to calculate AMZA's distribution coverage ratio or its actual net investment income, but the easiest is to simply take a look at the fund's SEC yield. This metric is equivalent to the fund's investment income, mostly distributions and dividends, minus expenses, for the past 30 days, divided over NAV, annualized. It basically shows the fund's dividend yield, sans return of capital distributions. AMZA's SEC yield, as of 11/30/2018, is 9.91%, which, by my calculations, implies a distribution coverage ratio of 45%.
I also decided to calculate AMZA's distribution coverage myself, using the most recently available data, April 2018. I arrived at a distribution coverage ratio of 59%. AMZA's distribution coverage has most likely declined since April due to declining NAV, and some disastrous derivatives trades, so I believe this figure is consistent with the above calculation:
(Source: AMZA Semi-Annual Report - Chart by Author)
Now, MLPs have very complicated accounting standards, MLP funds even more so, so calculating a distribution coverage can be particularly tricky. I decided to take a look at previous articles to see what other authors had to say about AMZA's distribution coverage, there was actually a lively debate about the subject a few months back. Trapping Value came up with a distribution coverage of 78% in a previous article, using very generous allowances, his words not mine. It seems AMZA's distribution isn't even close to being covered, even under the rosiest of scenarios.
AMZA's low distribution coverage basically means the fund is selling off its own assets to fund its distribution. Although there is nothing inherently wrong or detrimental in this, it does mean the fund's yield isn't particularly informative of anything. Anyone can sell +10% of their holdings every year and call the proceeds a distribution, investors don't have to buy AMZA if that is what they want to do.
AMZA's low distribution coverage is a negative for the fund's shareholders for two reasons. First, it means the distribution is likely to be cut in the near-future, something few investors will like or want. Second, and more importantly, it means AMZA's NAV is continuously declining, which makes it more difficult to fund the distribution, which causes further reductions in NAV. Reductions in NAV also serve to increase the fund's leverage, although the fund has been able to successfully manage this in the past. AMZA's distribution is unsustainable, and detrimental to the fund and its shareholders.
Tying it up all Together
I wrote about AMZA's investment strategy, its past shareholder returns, and the fund's distribution yield because I believe that, together, they tell a very damning story. AMZA's overall investment strategy has been a miserable failure, significantly underperforming the industry and destroying shareholder capital through failed derivatives, options, and short-selling trades. The resulting reductions in NAV meant AMZA couldn't even begin to cover its distributions. Instead of cutting the distribution to a more manageable level, AMZA (mostly) kept it constant, and paid extremely destructive ROC distributions to its shareholders. These distributions further eroded the fund's NAV, making it even more difficult for AMZA to generate income and pay subsequent distributions, but causing its yield to surge. The resulting ultra-high yield served to mask the fund's sustained underperformance and destruction of shareholder capital, and I'm sure attracted many retail investors to the stock. AMZA's decision to maintain its unsustainable distribution throughout the years was, in my opinion, reckless, destructive, and self-defeating, and likely done to try and hide the fund's disastrous performance since inception.
Perhaps I'm wrong and most investors actually like ROC distributions, knew the fund's yield was unsustainable, and understood total shareholder returns were a completely different matter altogether, but I don't think so. In any case, I do hope AMZA's investment strategy proves successful in the future, and for shareholder returns to improve, but I don't think they will. AMZA will most likely keep making failed trades, underperforming, and paying unsustainable distributions to investors.
FEN is very similar to AMZA in its overall investment strategy. Both funds are actively managed, leveraged, use derivatives, and have some small holdings in non-midstream companies. However, FEN is much more conservatively managed, and has outperformed AMZA and the vast majority of its peers throughout the years:
Read more about FEN here.
MLPX is very different from AMZA. It is a very cheap, broad-based index fund, uses no leverage or derivatives, nor does it engage in short-selling or other similar investment strategies or trades. MLPX is one of the safest, least volatile MLP funds, and it also has performed better than most of its peers throughout the years:
Read more about MLPX here.
AMZA's failed investment and trading strategy has led to disastrous total shareholder returns since inception. AMZA's yield isn't being covered, isn't indicative of the fund's underlying income generation, and should be ignored. AMZA will, most likely, continue underperforming relative to the competition. There are better investment opportunities out there, investors should seize them.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.