Get into MLPs Through an ETF

05/15/2012 7:00 am EST

Focus: MLPS

The dividends of master limited partnerships have attracted a number of investors in an era of volatile equities trading. But tax implications have kept others away. Darren Schuringa tells why his ETF mitigates those tax concerns, while giving them exposure to the asset class.

Kate Stalter: Today we’re discussing a type of investment that has been growing more popular lately—or more talked about in any case—MLPs, or Master Limited Partnerships.

I’m on the phone with Darren Schuringa of Yorkville ETF Advisors. Darren, you recently launched an ETF called Yorkville High Income MLP (YMLP). Why did you start this, and what are the objectives?

Darren Schuringa: Kate, thank you for having me on, No. 1. Yorkville has been investing in the MLP asset class since the early 1990—which is important, because MLPs were created by an act of Congress in 1986.

The reason why we recently launched YMLP, which is the High Income ETF, was because most investors are looking at MLPs and they think of infrastructure. But because of our structure, we’ve divided the asset class really into two parts or two segments—infrastructure and commodity.

The value of infrastructure is toll roads. That’s what everyone’s been taught and, in fact, we argue that all MLPs are toll roads. Commodities, which is the focus—commodity MLPs of our initial product—offer higher income, faster distribution growth, yet no more risk, either at a price level or at a fundamental distribution level. We’re offering investors to a new segment of the MLP asset class, and that’s why we launched YMLP.

Kate Stalter: Can you say a little bit more about the distinction between pipeline MLPs—which does to be the category you hear about most in this area—and what you’re discussing regarding commodity-based MLPs?

Darren Schuringa: Absolutely. And, don’t get me wrong. We like all MLPs and we invest across the asset class, but when we looked at commodity MLPs we really saw a mispricing within the asset class.

And the reason for that mispricing is because of lack of knowledge of commodity MLPs. If you look at funds that are investing in it, there were no pure plays until ours came out, so even traditional investors in the MLP asset class are overlooking commodity opportunities because of the perception of risk.

If you look at the yield, that would also indicate—because the underlying index that our fund tracks has a yield of almost 9%, relative to the infrastructure index, which is a high 5 [percent]—so you’re picking up 50% more income, which would tell most investors risk and return, there’s got to be greater risk.

But, to my earlier point, when we did the analysis behind it, we found no greater fundamental risk, meaning distributions were no more tied to commodity prices than the infrastructure plays. And two, there was no greater price risk.

When we looked at maximum drawdown during the great recession we just came through, both infrastructure and commodity MLPs declined in price with the broader markets, but were within a percentage-and-a-half of each other in the maximum drawdown. So, again, not a broad difference.

The reason for that, on the commodity side—the reason for the lack of exposure to commodity prices—is No. 1, diversification. You have natural resource companies. You have exploration and production companies, marine transportation, and then propane companies. Within those four sectors, there’s 11 different industries, and the companies that comprise these various industries and sectors have two things:

  • Long-term contracts, which again are not relying upon commodity price movements, they’re insulated from them.
  • Sophisticated hedging programs.

In the case of an exploration and production company, 100% of your next 12 months’ production would be completely hedged—so it really doesn’t matter what commodity prices do over the next 12 months—and then 80% of the previous year’s.

And those are simple averages. Some companies in the E&P space are even hedged greater than that, going out for multiple years. That’s the reason you don’t have exposure to the underlying commodity prices.

The benefit of this is that you gain exposure to commodities, the long-term trends, because ultimately these contracts will roll over, without having to be right short-term on the spot price of commodities, which is an extremely difficult game. And we’re investors, not speculators.

Kate Stalter: I want to follow up on a couple of things you said there, Darren. One of them is in reference to the underlying index for this ETF. Tell us a little bit about that, and how come nobody had formed an ETF around this previously?

Darren Schuringa: Well, because there weren’t many. Our product—our ETF, YMLP—was only the second MLP ETF when it was launched, so there were not a lot of offerings in the market.

Yorkville, given our experience within the asset class—we’re really a research-driven organization. That’s our core competency—earlier in the year, we released a seminal study on the asset class. At the base of the study was, we created 15 different indices to track the partnership universe, so 100% of publicly traded partners are part of one of our indices.

And we went back to 1986 to track the entire asset class. It’s the most comprehensive body of data and analysis ever put together on publicly traded partnerships. And from this, dividing it into 15 distinct indices and composites, 9 distinct sectors, 15 indices in total—we learned a lot about MLPs that most people had never seen before.

One of the greatest things was in the segmentation between infrastructure and commodity on the MLPs. And we noticed that historically, MLPs—infrastructure versus commodity—commodity MLPs had traditionally paid higher yields, relative to infrastructure, had faster distribution growth. But based on our analysis, no greater risk profile.

It was such an obvious investment opportunity, or mispriced asset class, because of higher yield and greater growth; it should actually trade at a discount relative to infrastructure.



Kate Stalter: You said something else that’s pretty interesting, the distinction between your company—which sounds like you tend to be very research-based—versus those that market a lot of new ideas for ETFs. Can you talk about your company philosophy in that regard?

Darren Schuringa: Oh, absolutely. We are very much focused on the MLP asset class. So, again as I started this conversation, Jim Hug, who is our Chief Investment Officer of our MLP strategies, has been investing in MLPs since the early 1990s, and researching them.

Hug really just recognized very young into the inception of MLPs the favorable characteristics of the asset class: High current income, growing distributions, tax-advantaged income, and low correlation to broader asset classes. And he built a career around this. It’s really been in that philosophy that we’ve just continued to study, research, and analyze MLPs. Recently, we’ve been doing this again.

We celebrated our tenth-year track record for our MLP Core Income Strategy, which is in separately managed accounts, and there we’re recognized by Morningstar and by Barron’s as one of the top performing managers. We delivered 10% annualized alpha over the S&P 500. That’s per year—which is not 200 basis points; it’s 10% per year over ten years.

So we’ve been doing this for years, and it was really the opportunity of late: We need to help educate investors on the MLP asset class, because with the new vehicles we’re creating in the ETF—YMLP being an example—we’ve opened the asset class up to now, where before, because of K-1s, you couldn’t access it in a 401(k) or an IRA, due to bad income, unrelated business income. Also, tax-exempt entities couldn’t buy MLPs, generally speaking, because of the bad income.

Now, with the C-Corp structures, we’ve just opened up all of the favorable income characteristics, diversification benefits of MLPs, to the entire investable universe of any type of account or any type of investment vehicle.

So for us, it’s a really exciting opportunity to help educate investors who have overlooked MLPs, whether it’s for tax reasons, because the fund now produces a 1099 income—so we simplify taxes for individual investors. The same process of creating 1099 income creates good income for tax-exempt entities, which means it goes into 401(k)s, IRAs, as well as foundations, endowments, ERISA plans.

There’s just a new opportunity for us to educate the world on this asset class that’s often overlooked because of its unique tax characteristics.

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