Thanks to increased interest in energy investing and high payouts, the MLP space has been extremely popular among ETF investors. As a result, a number of issuers have sought to launch new products in this segment, nearly all of which have seen tremendous inflows in their short time on the market. The latest company to try its luck in this space looks to be Yorkville which is the first firm to use the turnkey service from Exchange-Traded Concepts to bring its High Income MLP ETF to market.
MLPs, or Master Limited partnerships, are publically traded partnerships that are generally engaged in the transportation, storage, production, or mining of minerals and natural resources. Generally speaking, an MLP will consist of a general partner and limited partners; general partners control the operations and management while the limited partners provide capital and are entitled to receive cash distributions. Obviously, investors in this space act as ‘limited partners’ and do not engage in operation and management of the assets (see Inside The Forgotten Energy ETFs).
The benefit of this structure is that MLPs generally don’t pay U.S. federal income taxes. This means MLP investors are generally not subject to double taxation, a key feature of the product structure. However, in order to qualify for this, MLPs must follow Section 7704(d) of the IRS code which states that the partnership must receive at least 90% of its income from qualifying sources. Additionally, the partnership must pay out almost all cash flows to holders as distributions, a stipulation which tends to make these securities have outsized payouts when compared to their more traditional peers.
The new fund will be just the second ETF in the space, tracking the Solactive High Income MLP Index. This benchmark includes all MLPs operating with one of the following as a substantial business segment: exploration and production of oil and/or natural gas; sale, distribution and retail marketing of propane and other natural gas liquids; marine transportation of one or more of the following: crude oil, dry bulk, refined products, liquefied natural gas (“LNG”), and other commodities; direct mining, production and marketing of natural resources, including timber, fertilizers, coal and other minerals (see A Closer Look At The Canadian Energy Income ETF).
Recently, this resulted in a product that was heavily concentrated in the energy sector, and it also included three royalty trusts along with 22 MLPs. While the product will include royalty trusts, it will remain focused on MLPs; royalty trusts will not make up more than 20% of the total index. It should also be noted that the fund requires component securities to have a market cap of at least $400 million with a three-month average daily trading volume of at least $1 million in order to be included in the Solactive Index.
Furthermore, the product will also take a number of steps in order to make sure that only the highest yielding securities are included in the fund. First, companies are ranked based on three key metrics; current yield, coverage ratio, and distribution growth. Once these ranks are calculated, the firm adds up the three and ranks all the component firms on this ‘total rank’. The 25 highest ranked firms on this metric are then chosen for inclusion in the benchmark, ensuring that the product has a focus on high yielding securities (read Top Three High Yield Financial ETFs).
Currently, most products in the MLP space are structured as ETNs in order to avoid some of the tax headaches that come with the space. YMLP is structured as a ‘C’ Corporation for federal income tax purposes which means that distributions are usually tax-deferred returns of capital. ETNs on the other hand, since they don’t actually hold the securities, are not subject to the same rules and payouts are pretty much identical to what investors see in other types of securities (investors should consult their tax professionals for more on how this can impact their portfolios).
While this may be an issue for some, the structure is clearly popular with investors already. The only other MLP ETF on the market today, the Alerian MLP ETF , has close to $2.8 billion in AUM and sees volume of about 1.4 million shares a day. This fund holds a similar number of securities and sees a comparable expense ratio at 0.85%-- three basis points more than YMLP. The fund also pays outs a high level to investors as the fund has a 5.9% yield. Nevertheless, if the MLP ETN space and the success of AMLP is any guide, there is plenty of room for many entrants in the space, suggesting that this brand new fund from Yorkville could see high levels of inflows in short order.
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