Pipeline Problems: MLP ETFs Try To Get It Together

Before oil prices started slumping, there was a belief that master limited partnerships (MLPs) and the exchange traded funds holding those stocks could be sturdy during oil bear markets.

The reasoning was simple. MLPs typically are not engaged in the exploration and production of oil and petroleum-related products. MLPs' business models are more dependent on the volumes of natural gas and oil moving through their pipelines than commodities prices so conventional wisdom previously dictated. While that still may be the case, MLPs and MLP ETFs have been hit by a double whammy of sliding oil prices and fears regarding higher interest rates.

Surprisingly, investors have remained dedicated to the asset class. For example, the Alerian MLP ETF AMLP is off 24.6 percent just this year, but that ETF has hauled in more than $454 million in new assets year-to-date.

“And while MLP ETPs long have been viewed as being more insulated than energy funds when it comes to energy-price volatility, the past year has shown that MLP ETPs are certainly not immune to such volatility. Now, with continued uncertainty in energy prices, concerns about growth in emerging markets, still-growing U.S. energy production, and interest-rate increases on the horizon, MLP ETP investors who have enjoyed solid returns over the past few years--including valuable income in an environment where interest rates have hovered near zero--may find themselves at a crossroads. Looking ahead, while some dynamics--interest-rate movements and commodity prices--will always be difficult to forecast over the longer term, MLP ETP investors should be well prepared for the impact from such dynamics on the funds they hold,” said Morningstar in a new research note. 

Today, there are more than 25 MLP ETFs on the market with more than $25 billion in combined assets under management. AMLP is the giant of the group with $7.3 billion in assets. Home to familiar MLPs such as Enterprise Products Partners LP EPD, Energy Transfer Partners LP ETP and Magellan Midstream Partners LP MMP, AMLP also sports some jaw-dropping statistics.

Not only does AMLP show a whopping 38.8 percent 30-day SEC yield, but the ETF's net expense ratio is 5.43 percent, according to issuer data. 

“Because of legislation forbidding open-end funds from devoting more than 25% of their portfolios to MLPs, AMLP is structured as a C corporation. The upshot is that corporate tax liabilities mean AMLP's actual gross expense ratio is 5.43%, making it one of the most expensive ETPs on the market after taxes,” notes Morningstar.

AMLP and rival MLP ETFs have gotten some relief, albeit modest, in recent weeks. That relief is partly attributable to the Fed standing pat on interest rates. AMLP is up 1.3 percent over the past month because higher interest rates, mean higher financing costs for MLPs. Those higher financing costs, if they come to pass, could strain dividends, a phenomenon utilities and REITs investors might also have to grapple with if rates rise.