Broken Product Alert: JPMorgan Alerian MLP ETN Converting To Closed-End Note (AMJ, GAZ, TVIX, JPM)
Ron Rowland: JPMorgan Chase (NYSE:JPM) announced that one day soon it intends to halt new note creation for the JPMorgan Alerian MLP ETN (NYSEARCA:AMJ). When that day arrives, AMJ will become a broken product. Unfortunately, most shareholders, traders, and potential investors will not be made aware of this event when it does occur. Furthermore, regulators are not doing anything to prevent harm to the innocent bystanders – the unknowing owners.
Share creation and redemption are the heart and soul of ETPs – it’s what makes ETFs and ETNs unique. Take that away and they become broken products living as closed-end funds, which at times are subject to large and unjustifiable premiums. There is a gaping hole in current ETF regulation – purchasers are not required to be informed they are buying a broken product that may be trading at an exorbitant premium. These premiums will eventually collapse and leave the last buyers in holding the bag.
JPMorgan Chase offered no explanation for capping the number of notes at 129 million but did say this would equate to a total market cap of about $4.7 billion at current prices. About 118 million notes exist now, so the newly imposed cap is quickly approaching. My guess is that this action comes as a result of new “risk management” rules being put in place at JPM stemming from the recent $2 billion trading loss debacle. I’m further guessing these new risk rules attempt to limit exposure on any single product to $5 billion.
My stance on broken products is clear: they should not be allowed to trade without a failsafe mechanism of informing current and potential owners that the products are broken. This problem has existed for years with one broken ETN trading at a 1,000% premium. Contrary to popular belief, it is not limited to ETNs – ETFs are vulnerable to the same problem. Even recent destructive action in iPath Dow Jones UBS Natural Gas ETN (NYSEARCA:GAZ) and VelocityShares Daily 2x VIX Short-Term Futures ETN (NYSEARCA:TVIX) has not gotten regulators to take appropriate action.
Investors should avoid any new purchases of JPMorgan Alerian MLP ETNs (NYSEARCA:AMJ) as it is now a disaster waiting to happen. Current holders should devise an exit strategy that disposes of their positions before a premium collapse. Short sellers should monitor future price action for potential opportunities.
To clients of Capital Cities Asset Management: you do not need to take any action at this time. I will be monitoring this closely and plan to replace AMJ positions before any problems arise.
To subscribers of AllStarInvestor.com: you do not need to take any action at this time. You will be given instructions in regular updates on when and how to sell AMJ and what will be its replacement.
To everyone else: good luck.
Disclosure covering writer: Long AMJ for a little while longer.
Ron Rowland is the founder of Invest With An Edge and serves as the Executive Editor. He is also editor of AllStarInvestor.com and Chief Investment Officer of Capital Cities Asset Management(www.ccam.com). Quoted widely in the financial media, Ron is the industry go-to guy for sector rotation insight and investment strategies using ETFs and mutual funds.