Liquid Alternative Monthly Spotlight

saupload_MLP-ETFsThis month: Master Limited Partnerships (MLPs)

For the next few months, I will spotlight a strategy utilized within our Liquid Alternatives model to give the reader a better idea of what “alternative” means and how it adds value. To start our series off, we will talk about MLPs.

Master Limited Partnerships, or MLPs for short, are limited partnerships that are publicly traded. The majority of MLPs currently operate in the energy infrastructure industry, owning assets such as pipelines that transport crude oil, natural gas and other refined petroleum products. MLPs typically generate fee-based revenues, which tend not to be directly tied to changes in commodity prices. In other words, these companies are like toll-keepers, picking up a fee every time someone has to transport a product. We like this because it is not about the commodity that they’re transporting – those tend to be quite volatile – it is really just about the steady, consistent “toll” they bring in.

In our Liquid Alternative model, DWM uses the JPMorgan Alerian MLP Index ETN (symbol: AMJ) for this MLP exposure. AMJ tracks a variety of different types of MLPs: petroleum transportation, natural gas pipelines, propane, exploration/production, and gathering and processing. These firms operate at various stages of the transportation of energy. The largest MLPs own several businesses to capitalize on their scale and offer start-to-finish services. Kinder Morgan is an example of an MLP like this and a company you may have heard of before. Federal regulations require new energy projects to undergo a rigorous vetting process, so economically unviable pipelines are rarely built. As a result, most pipelines and processing facilities run by MLPS are local monopolies and are quite lucrative.

We like MLPs for a number of reasons. First, they provide relatively low correlation to the traditional asset classes of equities and bonds. Second, they have produced attractive yields – current yield of AMJ is around 4.68%. Third, in the past few years besides the nice coupon, there’s also been price appreciation. In fact, AMJ’s 3 yr annualized total return as of 6/12/13 was 20.91%.

Some people knock MLPs because typically the burdensome K-1 forms are associated with them. But because we use AMJ, which is an exchange traded note from JPMorgan, investors get the friendlier 1099 tax form. Another advantage of AMJ is the diversification it provides: the Alerian MLP Index is a market-cap weighted, float-adjusted index that covers the major players (Enterprise Products, Kinder Morgan, Plains All American Pipeline, Magellan, etc) within the MLP space.

As you can see, MLPs are a different breed and we think make for a compelling investment opportunity. As such, AMJ is a star player on our Liquid Alternative team. Next month we will introduce you to some other stars also on that team!