As interest rates continue to sit at historic levels, investors looking for income have become accustom to adding some "exotic" assets to their portfolios in order to find yield. One such asset class has pipeline master limited partnerships (MLP). Featuring high tax-advantaged distributions, interest in MLP's have surged over the last few years. However, popularity has its drawbacks. While the sector isn't necessarily overvalued, one of the key ways for investors to add this income producing asset class has recently undergone some growing pains. For investors seeking MLP exposure, knowing your alternative is key.
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Waiting for a Premium Collapse
For investors seeking high MLP dividends, the JPMorgan Alerian MLP Index ETN (ARCA:AMJ) has been the go-to investment for portfolios. The exchange traded note (ETN) tracked a basket of various pipeline firms such as Enterprise Products Partners LP (NYSE:EPD) and ONEOK Partners, L.P (NYSE:OKS) and paid a hefty 5% dividend. The beauty of the ETN structure is that coupons paid from the note are reported on 1099s come tax time, and eliminate the administrative burden associated with K-1 forms that come with owning individual MLPs. That feature allowed the ETN to amass more than $4 billion in assets from investors.
However, that popularity is where the fund has come to suffer. Issuer JMP Group (NYSE:JMP) recently capped the size of the note at 129 million shares. The share creation and redemption feature of ETNs and exchange-traded funds (ETFs) is what keeps them close to their net asset values. By capping the number of shares, AMJ has now boosted the odds that the security's price may become unhinged from its value and trade at a huge premium. When those price premiums collapse, investors end up losing big. Investors in the VelocityShares Daily 2x VIX ST ETN (ARCA:TVIX) saw the fund lose more than 50% of its value as its premium vanished.
SEE: Exchange Traded Notes - An Alternative To ETFs
Plenty of Choices
For investor's still seeking MLP exposure, especially those wanting to escape the K-1 tax headaches, the capping of AMJ shares poses a major problem. It's still too early to tell what will happen to the note and how it will react in the future. That adds a whole other layer of risk to the product that investors shouldn't have to deal with. Nonetheless, there are plenty of alternatives for investors looking to add the high yielding asset class to a portfolio. Here are some picks.
Tracking the same index as the AMJ is the ETF-based ALPS Alerian MLP ETF (ARCA:AMLP). Like the ETN, the fund allows investors to own a basket of pipeline, gathering system and storage firms without the hassle of a K-1 statement. While expenses for the fund are high (currently at 4.86%) due to tax issues resulting from ETFs holding MLPs, the fund is one of the best choices for switching out AMJ. Likewise, the newly launched actively managed First Trust North American Energy Infrastructure (ARCA:EMLP) and 8.8% yielding Yorkville High Income MLP ETF (ARCA:YMLP) make interesting choices as well.
Like the ETF space, there are a handful of closed-end funds (CEF) that invest primarily in publicly traded MLP companies. The CEF structure also allows investors to avoid those dreaded K-1 statements come tax time. Additionally, investors have the ability to purchase shares at discounts to the net asset value (NAV) as well as receive higher distributions due to leverage. However, like AMJ, some CEFs in the space trade at large premiums. These include the Kayne Anderson MLP (NYSE:KYN) at 13.58% and the Cushing MLP Total Return Fund (NYSE:SRV) at 24.24%.
A better bet might be the MLP & Strategic Equity Fund (NYSE:MTP). The CEF is currently trading at its NAV, but has traded at wide discounts before. The fund holds a wide variety of midstream firms and currently yields a market beating 5.65%.
SEE: Discover Master Limited Partnerships
The Bottom Line
With interest rates continuing to hover around zero, investors have looked to alternatives to find yield. One popular asset class has been MLPs and the JPMorgan Alerian MLP Index ETN. However, with the fund now limiting new share creation, investors could be in for a world of hurt. Luckily, there are plenty of other ways to get your MLP fix. The previous picks, along with the Global X MLP ETF (ARCA:MLPA) make ideal choices.
At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.