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InfraCap MLP : High Yield in Energy

12/20/2016 9:00 am EST


Tim Plaehn

Investment Research Analyst, Investors Alley

I’ve receive quite a few questions about one of our recommendations — an exchange-traded fund that focuses on energy-related master limited partnerships, notes Tim Plaehn, editor of Investor Alley's The Dividend Hunter.

The InfraCap MLP ETF (AMZA) — with a 19% dividend yield — is on our recommendation list as a high-yield way to invest in the energy infrastructure MLP sector.

I recently communicated with the fund management team, so I think it is a good time to give an update on the fund. To start here is an overview of the fund's investment goals and strategies.

AMZA is the first actively managed ETF in the MLP-focused space. The fund owns the same MLPs as the ones tracked by the Alerian MLP Infrastructure Index, with the following possible enhancements:

* The fund manager can weight individual MLPs holdings different than the index.

* AMZA will weight these same MLPs based on the return potential from the management team's proprietary algorithm.

*The fund can own the publicly traded general partner (GP) companies of the index component MLPs.

* The fund can sell call options (covered call strategy) to generate extra cash income from the portfolio.

* Fund managers can use leverage (up to 33% of the portfolio). Leverage in an MLP fund helps offset a portion of the corporate income tax drag.

I contacted Ed Ryan, one of the portfolio managers, with a few questions about AMZA.

It is good news to see that fund assets have grown tremendously this year, currently $135 million, compared to about $19 million at the start of 2016.

The rapid growth in assets provides some challenges for the fund managers, but is very good news for us as long-term investors.

The growth in assets has affected the dividend coverage, with a lot of the new money coming in just before dividend payments. That money does not get invested in time to generate cash earnings, yet the fund still pays the dividends on the new shares.

Ed stated they currently do not think they will have to change the dividend rate since net capital gains (which have to be paid out at some point anyway) have been enough to support the current dividend.

Of more interest to me is the fund managers' belief that MLPs are still greatly undervalued.

They view the BBB bond yield as a benchmark for the midstream sector yield. That bond yield is now at about 4%, and midstream energy stocks are priced to yield an average of about 8%.

That spread is expected to narrow, and even if bond yields rise, MLP prices should also rise to help close the rate spread between the two asset classes.

So even in a rising interest rate environment, MLPs and the AMZA share prices are poised to gain in value. In the meantime, we will continue to collect the high current dividend yield.

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