MLPX: New Global X ETF is Not an MLP ETF

August 13, 2013 by  
Filed under Commentary, ETF IPOs (New ETFs)

Global X introduced a new energy ETF last week (8/7/13), touting it as the lowest cost MLP ETF and one that does not incur corporate taxes.  However, the new ETF, dubbed the Global X MLP & Energy Infrastructure ETF (MLPX), is not an MLP ETF.  It is an energy sector ETF restricting its MLP holdings to less than 25% of its portfolio.  By doing so, it can operate as a Regulated Investment Company (“RIC”) instead of a C-corporation liable for federal and state income taxes.

The fund will attempt to track a new Solactive index consisting of 35 holdings that limits exposure to MLPs in order to comply with applicable tax diversification rules.  The industry breakdown indicates a 77% allocation to natural gas pipelines and 23% to petroleum pipelines. 

There are no MLPs among the seven largest holdings, which are Kinder Morgan Inc (KMI) 9.1%, Transcanada Corp (TRP) 8.9%, Enbridge Inc (ENB) 8.8%, Williams Companies Inc (WMB) 7.9%, Spectra Energy Corp (SE) 6.8%, EQT Corp (EQT) 6.4%, and ONEOK Inc (OKE) 4.5%.

No yield information could be located on either the fund’s or index provider’s websites.  Additional information can be found in the MLPX overview, fact sheet (pdf), investment case (pdf), and prospectus (pdf).

Analysis/Opinion:  There are numerous discrepancies in the MLPX marketing literature.  First of all, there are more than 50 exchange traded products (“ETPs) in the ETF Field Guide targeting the U.S. energy sector, and I’m not aware of any that are prevented from placing up to 25% of their portfolios into MLPs.  MLPX is not an MLP ETF, it is an energy sector ETF. 

The press release (pdf) claims MLPX is “taking advantage of a fund structure unique to MLP ETFs to provide greater tax efficiency for shareholders.  Due to its structure as a Regulated Investment Company, MLPX is not subject to corporate taxes.”

Regulated Investment Companies (“RICs”) were defined 73 years ago in the Investment Company Act of 1940.  Nearly every mutual fund, closed-end fund, and ETF (except those with more than 25% in MLPs) is a RIC and not subject to corporate taxes.  The C-corporation structure is used by only about a dozen of the more than 10,000 mutual funds and ETFs tracked by Morningstar.  Claiming the RIC structure is “unique” when more than 99% of funds use it is beyond comprehension.

Earlier versions of the marketing materials claimed, “The fund is taxed as a regular corporation for federal tax purposes, which differs from most investment companies.”  Apparently, that was an incorrect carryover from their “real” MLP ETFs.  However, the following disclaimer is now made, “The Fund has a different and more complex tax structure than traditional ETFs and investors should consider carefully the significant tax implications of an investment in the Fund.”

I was the first analyst to warn investors about the tax consequences and the subsequent performance drag of buying MLPs in an ETF wrapper.  Indeed, the first MLP ETF structured as a C-corporation, the Alerian MLP ETF (AMLP), has lagged its index by 31% since inception.

Although all RIC structured energy ETFs throughout history have implicitly limited their MLP exposure to 25%, a few funds have explicitly expressed this recently.  To my knowledge, the first to do so was the Arrow Dow Jones Global Yield (GYLD) in May 2012. 

The First Trust North American Energy Infrastructure ETF (EMLP), launched in June of 2012, also explicitly limits its MLP exposure to less than 25% to preserve its RIC status.  EMLP is a direct competitor of the new MLPX.  They both target the energy infrastructure industry.  In my opinion, the major difference is that the First Trust ETF doesn’t try to mislead investors by calling itself an MLP fund.

Investors wanting a 10% exposure to MLPs in their portfolio have five options.  They can: 

  1. buy MLPs directly and deal with the K-1s and potential UBTI taxes
  2. buy MLP ETNs and deal with the credit risk and distributions that are current-year-taxable
  3. buy MLP ETFs and suffer the historical 8% annual underperformance
  4. wait for a sponsor to offer an MLP ETF that tracks its index 
  5. buy a 40% allocation of either MLPX or EMLP

Option 5 will potentially provide the 10% MLP allocation desired.  However, I don’t think having a 40% portfolio allocation to energy infrastructure is a prudent move.  Now, if your desire is to have only a 2% portfolio allocation to MLPs, then an 8% allocation to MLPX or EMLP becomes more realistic.

8/16/13 revision/addition:  Option 3 also applies to MLP mutual funds and MLP CEFs (closed-end funds), which are also structured as C-corporations.  However, most (or all) of them do not claim to track an index, so it is more difficult to accurately determine the full impact of entity level taxation. 

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Comments

2 Responses to “MLPX: New Global X ETF is Not an MLP ETF”

  1. A A Young on August 14th, 2013 6:38 pm

    Misleading marketing materials should be busted with the full force of the law. This kind of flim-flam deserves not just a blog post, but a formal SEC complaint.

    But I don’t agree with all of your analysis.
    1. Even though they may only have 25% directly in MLPs, their largest holdings are general partners of the same companies. So they invested in the same infrastructure as the MLPs. This is different from an energy-sector fund, which targets producers, retailers, etc. Or to put it another way, when MLPs rise, general partners usually make even more, so it’s effectively the same exposure.

    Also, you left off additional investment options. There are a number of managed CEFs and OEFs which hold MLPs and do not have the counterparty risk of the ETNs. Performance is always a question, of course, but a bit of diversification in fund managers reduces that risk as well.

  2. Ron Rowland on August 15th, 2013 9:25 am

    Thank you for your comments. Your points are valid. However, I disagree that it is different from an energy sector fund. For example, KMI is the top holding in MLPX and is also a component of most major energy indexes and energy funds.

    The general partners also have other business operations which may detract from this business. Also, since they are structured as taxable corporations, it is not the same as owning non-taxed MLPs. While the general partners have the “potential” to be more profitable, the performance of EMLP suggests otherwise.

    Yes, my failure to include MLP CEFs as an option was an oversight on my part. I will add that.

    I have not been personally harmed by MLPX and as a result of my own due diligence, I have not been personally misled. Therefore, I have no personal reason to file a complaint.

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