MLPs: What You Didn’t Know-ETP Insight From An Expert

Chris Hempstead, WallachBeth Capital

It took only 18 months for assets in MLP exchange traded products to grow from almost nothing to nearly $7.5bb.

What’s more amazing is that while the number of ETPs available in the market has grown significantly, nearly all of the inflow of assets into MLP ETPs has been captured by only 2 funds:

AMJJPMorgan Alerian MLP Index ETN $4.2bb assets under mgmt.

AMLPAlerian MLP ETF $3.25bb assets under mgmt.

This success story has recently attracted more funds into the space and we expect that trend to continue.

The most recent launches in the MLP space are YMLP (Yorkville High Income MLP ETF) and the MLPA (Global X MLP ETF).

Here is the twist that precipitated this note: JPMorgan has announced (June 14) that they will cap the issuance in AMJ at 129mm notes.

This will bode well for the ETFs tracking the MLP space. A brief explanation below may help shed light on this.

When an ETP no longer allows for creations, the fund starts to trade like a closed end fund. The reasoning behind this is that the arbitrage mechanism which allows market makers to sell the ETP is no longer available. Without the ability to create, market makers may be less inclined to sell the fund short versus a hedge of the underlying assets.

It should be noted that this is only a cap of notes issued. Should the fund reach the cap (we expect it will very soon) and redemptions follow, the fund would allow creates until it reached the cap again.

So what happens now?

We simply wait and see. When AMJ reaches the maximum threshold, we will closely monitor the availability of AMJ notes available in stock loan as well as any premium in the funds pricing on the secondary market.This could bode well in the short term for existing holders of AMJ as the fund will likely trade at a premium once the creation facility is shut down. Early investors would not have expected this so it’s a win for them.

That being said, once this happens I expect investors looking at MLP ETPs will be drawn away from the AMJ ETN and towards the ETFs mentioned above. Why? With the creation facility wide open in ETF funds like AMLP, YMLP and MLPA we expect them to trade and track at or close to their respective net asset values.

Q.Will investors use the close substitutes available instead of buying into a premium product that could erode.

A.The premium risk for “new” buyers is that the premium stays the same or erodes. In this case another product with similar exposure would better serve their needs.

The premium risk for “pre-premium” owners is that JPM opens the fund up for creations again, which will collapse the premium.

Q. Why is the note hard to hedge? I get why TVIX is/was but AMJ tracks an index with liquid underlyings. Is the tax liability of the product that much of a hurdle in tracking/hedging? I’ve heard this gets exacerbated in an up trending market.

A. “Hard to hedge” is a subjective phrase; those seeking insight on hedging strategies are invited to contact our trading desk to discuss approaches that meet specific objectives. Regarding taxes, an FYI is that AMLP just began trading with tax deferred asset.  Important news.

Chris Hempstead is head of ETF Execution for WallachBeth Capital LLC.