Income investors have always had an affinity for master limited partnerships, or MLPs. These unique vehicles offer exposure to the energy sector through a high yield, equity-like security. Their business models and tax structures are such that they can pass through a great deal of their profits to shareholders in the form of dividends. This makes them coveted for both their unconventional returns vs stocks or bonds in addition to their healthy income streams.
Those who have dabbled in owning MLPs through an exchange-traded product are probably most familiar with the venerable ALPS Alerian MLP (NYSE:AMLP) or JP Morgan Chase (NYSE:JPM) Alerian Exp 24 May 2024 (NYSE:AMJ). Together these two funds control nearly $15 billion in total assets in a concentrated group of the largest MLPs by market capitalization.
I consider these indexes the first generation of MLP fund exposure and they surely get the job done. However, like any technology or innovative process, there is room for improvement in many areas. For starters, the expenses on these funds are still quite high compared to traditional stock-like indexes. There is also room for improving the index construction criteria to broaden exposure to this group or hone in on varying characteristics of the MLPs themselves.
Fortunately, the second generation of MLP funds is now taking note of these shortcomings and improving on them dramatically. At the tip of this spear is a relatively new fund that is rapidly becoming one of my favorites in the class.
The Tortoise North American Pipeline (NYSE:TPYP) is nearing its second anniversary and has accumulated $72 million in total assets. This unique ETF tracks the Tortoise North American Pipeline Index, which represents a benchmark of energy pipeline, distribution, storage, and processing companies.
The fund is more diversified than a pure MLP index. In fact, it has 55% of the portfolio in traditional MLPs and the remaining in energy-related corporations and LLCs. This broadens the exposure to include nearly 90 stocks rather than the conventional 25-40 holdings that most dedicated MLP indexes are beholden to.
I tend to like greater diversification because it reduces single-sector volatility, while still allowing investors to participate in the overall trend and price action. Top holdings are in familiar names such as: Williams Companies Inc (NYSE:WMB), TransCanada Corporation (TO:TRP), Enbridge Inc (NYSE:ENB), and Kinder Morgan Inc (NYSE:KMI).
Other than the obvious benefits of diversification, another advantage of investing in this sector through an ETF is that investors aren’t subject to a K-1 tax form. Owners of TPYP (and similar ETFs) are subject to standard 1099 dividend income just like a traditional stock fund.
TPYP also offers the lowest expense ratio of its peers at just 0.40%. That’s less than half the 0.85% management fee of a fund like AMLP. It’s also significantly lower than the actively managed First Trust North American Energy Infrastructure (NYSE:EMLP) expense ratio of 0.95%.
EMLP is a closer comparison in terms of the underlying portfolio to the type of index strategy that is achieved in TPYP. It’s also a fund that I have favorably reviewed in the past and has seen its assets under management grow to over $1.6 billion.
It’s worth noting that the broader industry coverage of TPYP also works against it in terms of the portfolio yield. As of the March 31, 2017 ETF fact sheet, the listed distribution yield is at 4.40%. That’s meaningfully lower than many other aggressive yield-seeking MLP funds that target smaller companies or distressed assets in search of high income. Nevertheless, those types of funds are going to come with a much higher risk of invested capital as well.
The Bottom Line
Both MLP veterans and industry newbies can find things to like about the structure of the TPYP portfolio. It brings many positive attributes to the table and is one of my new favorite ETFs for diversified access to this sector.
The key of course is finding the right time to add this type of fund to your ETF income portfolio. While I haven’t made an allocation yet, this will become a staple on my watch list for a small tactical position when the right risk/reward setup is presented to us.
Disclosure : FMD Capital Management, its executives, and/or its clients June hold positions in the ETFs, mutual funds or any investment asset mentioned in this article. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.
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