New Junior MLP ETF (MLPJ) Has 38% Daily Tracking Error
Ron Rowland: Today (1/15/13), Global X launched another C-corporation masquerading as an ETF. The Global X Junior MLP ETF (NYSEARCA:MLPJ) elected not to be a regulated investment company. Like the other C-corporation ETFs that came before it, I believe MLPJ’s marketing literature falls far short of informing potential investors of the impacts of this election. One of the most misleading parts of the prospectus (pdf) is the opening line:
The Global X Junior MLP ETF (“Fund”) seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Solactive Junior MLP Index (“Underlying Index”).
However, by design, MLPJ will have a daily tracking error of about 38%. Each day’s NAV change will be about 38% less than that of the underlying index. I guess their dictionary defines “generally” as being within 39%.
Next on page 1 of the prospectus is the Fees and Expenses section, where it states that “Other Expenses” are 0.00%. The footnotes say:
“Other Expenses” reflect estimated expenses for the Fund’s first fiscal year of operations. “Other Expenses” does not reflect deferred income tax liability to be incurred by the Fund.
Although they know that “Other Expenses” are in the neighborhood of 38% of the daily percentage index change, they are estimating them to be zero. This is further explained by:
The Fund’s accrued deferred tax liability will be reflected each day in the Fund’s net asset value per share.
The Fund will be subject to taxation on its taxable income. The NAV of Shares will also be reduced by the accrual of any deferred tax liabilities.
The Fund will generally compute deferred income taxes based on the federal income tax rate applicable to corporations currently 35% and an assumed rate attributable to state taxes.
The Fund is taxed as a regular corporation for federal income tax purposes. This differs from most investment companies, which elect to be treated as “regulated investment companies” under the Code in order to avoid paying entity level income taxes.
The Fund’s taxable distributions will generally be taxed as ordinary income or capital gains.
In other words, MLPJ is going to give the NAV change a 38% haircut every day. It is going to account for taxes by adjusting the NAV, and shareholders will bear the burden, but MLPJ is not going to call it an expense.
The worst part about this is the fact that regulators let them get away with it.
If the idea of having 38% of your capital gains confiscated before you pay your own individual taxes on those gains is appealing, then you should consider investing in an MLP ETF like the Global X Junior MLP ETF (MLPJ).
The underlying Solactive Junior MLP Index is intended to give investors a means of tracking the overall performance of the small-capitalization segment of the United States master limited partnerships (MLP) asset class.
The index currently has 25 holdings including Suburban Propane Partners LP (SPH) 6.8%, Northern Tier Energy LP (NTI) 6.6%, Alliance Resources Partners (ARLP) 6.5%, TC Pipelines LP (TCP) 6.4%, and Natural Resource Partners LP (NRP) 6.3%.
Industry breakdown includes Exploration & Production 44.0%, Energy Transportation & Storage 39.5%, Refining & Distribution 13.4%, and Energy Equipment 3.2%.
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.