A New Way to Play MLPs

09/22/2010 12:00 pm EST

Focus: ETFS

Richard Young

Editor, Young's Intelligence Report

Richard C. Young, editor of Intelligence Report, tells about a new ETF that tracks some of the biggest master limited partnerships traded in the US.

The newly listed Alerian MLP ETF (NYSEArca: AMLP) is an index fund that tracks the Alerian Master Limited Partnership (MLP) Infrastructure Index—a composite of 25 energy infrastructure MLPs that earn a majority of their cash flow from the transportation, storage, and processing of energy commodities. Individual component weightings are limited to a maximum of 10% of the index.

To be included in [the index], an MLP must earn at least 50% of its distributable cash flow from energy infrastructure assets that are not directly exposed to commodity prices. Here, the goal is to maximize the stability of cash flow and unit-holder distributions. By excluding exploration-focused MLPs, the Alerian index should achieve more consistent dividend payments.

The Alerian ETF compares favorably to the closed-end MLP funds on the market. [It] uses no leverage and can be purchased at or within a few basis points of net asset value throughout the day. Closed-end MLP funds often employ leverage of three to one and trade at wide premiums to net asset value. The Alerian ETF also has a lower expense ratio than many of the closed-end MLP funds currently on the market.

The ETF's top holding is Enterprise Products Partners (NYSE: EPD), [America’s] largest publicly traded energy partnership. The company's assets include almost 21,000 miles of natural gas pipelines; 17,033 miles of NGL (natural gas liquids) and petrochemical pipelines; 5,403 miles of crude oil pipelines, and 5,704 miles of refined products pipelines, as well as 27 billion cubic feet of natural gas storage capacity.

Enterprise has raised its distribution for 24 consecutive quarters. Since the firm's initial public offering, distributions have grown at a compound annual rate of 8%. On an annualized basis over the last decade, EPD has returned over 20% to shareholders compared to a 0.76% loss on the Standard & Poor’s 500.

Another of the Alerian fund's top-five holdings is Magellan Midstream Partners (NYSE: MMP). [Its] combination of an investment-grade rating and lack of incentive distribution rights keeps the cost of both debt and equity capital low. (Incentive distribution rights give preferential treatment to general partners—big investors—in the cash an MLP can distribute—Editor.)

MMP owns the longest petroleum products pipeline in the country, a 1,100-mile ammonia pipeline, and six marine storage terminals. Magellan shares yield 6%, and management is targeting annual distribution growth of 4%. Add the current yield to the distribution growth target and you have a 10% [potential annual] return.

The Alerian ETF allows you to invest in MLPs in your tax-deferred accounts without adverse tax consequences. And because the Alerian ETF is structured as a corporation, the tax filings are simplified: There are no K-1s to file, [while] distributions are considered qualified dividends and reported on a Form 1099.

(Editor’s note: For another broad-based fund of master limited partnerships, read about JPMorgan Alerian MLP Index ETN (NYSEArca: AMJ) here in Top Pros’ Top Picks.)

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