A New MLP Fund With a New Approach

A New MLP Fund With A New Approach
Master limited partnership (MLP) units are one of the most attractive investment categories
available to income focused stock investors. From the list of MLPs and related companies you can
find a wide range of attractive current yields, with many of the companies dedicated to increasing
their distribution rates on a regular basis. However, in some circumstances an investor would like to
own a basket of MLPs in a single fund-type product. The financial services industry has developed
and offers MLP focused exchange traded funds (ETFs), closed-end funds (CEFs), exchange traded
notes (ETNs) and mutual funds. However, there is a significant issue with MLP funds vs. funds that
own regular, corporate stock shares.
Funds that focus on MLPs also must deal with additional tax issues. If an MLP focused fund has
more than 25% of its assets in partnership units, the fund cannot qualify as a non-taxable, regulated
investment company (RIC). The tax rules force any fund with a higher percentage of MLP assets to
be organized as a corporation and to pay corporate taxes on its profits.
In practice an MLP fund tracks the accrued income taxes on the gains in its portfolio and subtracts
the future tax liability from the fund’s net asset value (NAV). The result of a 35% to 40% corporate
income tax bill is that the NAV of a fund will lag the gains in the portfolio by the tax rate. For
example, the Alerian MLP Infrastructure Index (NYSE: AMZI) is one of the most widely followed
indicators of MLP sector returns. The index is mirrored by the ALPS Alerian MLP ETF (NYSE: AMLP).
Over the three years that ended on December, 2014 the index had recorded an average annual
return of 13.24%. For the same period, the AMLP ETF produced average returns of 8.18% per year,
a 38% per year under-performance compared to the index. For this reason I have not
recommended MLP ETFs as an investment option for the MLP sector.
Introducing InfraCap MLP ETF



Launched in October 2014, the InfraCap MLP ETF (NYSE:AMZA) is just now getting its position in
the market solidified. AMZA was established as one of a new breed of ETFs. Traditional ETFs
automatically buy and hold securities to match the securities tracked by a specific index. Over the
last year, fund companies have started to come up with actively management ETFs, which mix the
characteristics of an index fund with additional investment criteria from an investment advisor.
AMZA is the first actively managed ETF in MLP-focused funds space. Here is how the InfraCap MLP
ETF is designed to operate:
The fund will own the same MLPs as the ones tracked by the Alerian MLP Infrastructure Index, with
the following possible enhancements to the index:



The fund manager can weight individual MLPs holdings different than the index. The AMZI is strictly
market cap weighted, tracking the 25 largest midstream MLPs, with bigger MLPs having a greater
weight on fund performance. 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 companies of the index component MLPs.
The general partner of an MLP can generate an accelerated level of cash flow growth compared to
the limited partnership it manages. The GP companies can produce extra capital gains for the fund
and a faster growing distribution cash flow stream.



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



Fund managers can use a moderate amount of leverage (up to 33% of the portfolio). Leverage in an
MLP fund helps offset a portion of the corporate income tax drag.
These strategies are in wide-spread usage by the MLP-focused closed-end funds. When I was
provided the opportunity to interview the InfraCap fund managers, my first question was why they
had selected to go with the ETF structure rather than as a CEF. The answer was the management
team wanted to provide a higher level of visibility on what is happening in the portfolio. They are
and it is a good thing. Also, the ETF structure allows the fund sponsor to use some additional tools
to keep the market share price in line with the fund’s net asset value (NAV). Closed-end fund shares
often trade at significant discounts or premiums to their NAVs. An ETF should have a market share
price that is within a few cents of the NAV.
At the end of the investment research, AMZA provides an MLP ETF with a high level of visibility on
how it operates. Over time, investment results can be directly compared to the AMLP ETF, which
owns the same MLPs to track the AMZI index. This allows us to directly track whether InfraCaps
enhancement strategies are working to produce a better return.
Investment Potential
Before the prices of crude oil and natural gas started their steep declines in the last third of 2014,
the MLP sector had been producing outstanding returns for investors. This chart shows the AMZI
total return results for the last 10 years.

These investment results are the result of attractive distribution yields combined with steady
distribution growth. Although MLP stock market prices are down over the last six months, the
midstream distribution growth story of the 25 companies in the AMZI index remains intact. There
may be a few more rough patches for the MLP sector as the industry and market adjust to a
different energy pricing world, but long term investors will do well with the basket of MLPs
represented by AMZA.
The InfraCap MLP Fund paid $0.50 per share as its first quarterly dividend. That’s a 9.4% yield on
the current $22.19 share price. The management team told me their goal is to be able to increase
the dividend rate every quarter. AMZA works as an attractive high-yield choice for investors who
want energy sector and MLP exposure but do not want to own individual units. It can also be used
to get MLP coverage in an IRA, where I do not recommend the use of individual MLPs.