Direxion Rolls Out High Income MLP ETF [ETF Series Solutions, Alerian Mlp]

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February 6, 2014 5:27pm NYSE:AMJ NYSE:AMLP

direxion_logo2013 was pretty bumpy for interest-rate sensitive sectors like Master Limited Partnerships (MLPs) thanks to the Fed tapering talks which pushed up rates. Despite this sluggish trend, MLPs emerged as solid performers, and ended the year with decent average gains of about 16%.

With the Fed finally deciding on a soft QE cut-back (worth $10 billion per month) from January, investors appeared apprehensive about MLP performance heading into 2014. However, the trend doesn’t seem to be slowing down by any means.

In fact, the decent run in 2013, braving the rate issues, might have encouraged fund issuers like Direxion to roll out a new MLP ETF in the market. The issuer’s new MLP product called Zacks MLP High Income Shares ZMLP hit the market on January 23, 2014.

Zacks MLP High Income Shares: ZMLP 

This ETF looks to track the Zacks MLP Index which is a benchmark of master limited partnerships engaged in the transportation, storage, processing, refining, marketing, exploration, production, and mining of natural resources and trades on North American stock exchanges.

The index rules out companies not having at least $300,000,000 of market capitalization. The index follows a quantitative rule-based strategy and takes value, liquidity, short interest, dividend yield and other factors into consideration for inclusion in its portfolio.

Currently, the MLP ETF holds 25 firms in its basket. The components of the portfolio are equal weighted each having about 4% exposure of the total. In terms of individual holdings, Hi-Crush Partners LP (4.82%), Alon USA Partners, LP (4.71%), and NuStar Energy L.P. (4.55%) take up the top three spots.

The portfolio is inclined toward smaller capitalization levels as these take up about half of the exposure followed by mid caps which account for one-fourth of the total assets.

Investors should also note that ZMLP is tilted toward oil & gas pipelines (44%). Energy exploration, and oil refining and marketing also account for decent allocations at 17% and 16%, respectively. Rounding out the portfolio is an 8% allocation to natural gas utilities, 7% to coal & alternative energy, 5% to metal and mining and 4% to agricultural chemicals.

ZMLP charges an expense ratio of 65 basis points and looks to deliver a dividend yield of 7%. Another important trait of this product is its structure as an ETF.

Also, the product is built as a C-Corporation which takes care of the K-1 headache of investors. However, before shareholders get paid out, the C-Corp has to pay taxes, reducing the size of distributions but eliminating the tax disclosure issue.

How Does It Fit in a Portfolio?

This ETF could be an interesting choice for investors seeking broad exposure to the MLP space with a focus on income. Moreover, the use of an equal weight strategy could keep the portfolio balanced among various companies and help in avoiding heavy concentration risk.

The product is reasonably priced at 65 bps, though not extremely cheap, as the average expense ratio of the MLP ETFs space stands at 80 bps a year.  ZMLP is also one of the highest income generating instruments in the space. Hence, the fund carries the potential to attract investors (read: Boost Income and Growth with MLP ETFs).

Investors should realize that the product’s major focus on smaller caps equities will likely help it to trend higher in a reviving U.S. economy and deliver increased capital appreciation along with higher income payouts. All these could make ZMLP an interesting choice.

 Can it Succeed? 

At present, the MLP ETF space is overcrowded with Alerian MLP ETF (AMLP) topping the list having amassed about $7.58 billion in assets. Alerian MLP Index ETN (AMJ) and E-TRACS Alerian MLP Infrastructure Index (MLPI) round the top three positions with, respectively, $5.8 billion and $1.6 billion in assets. This will make it somewhat hard for ZMLP to attract huge onlookers without some solid outperformance.

One good point is that these three have expense ratios at 0.85% which is way higher than what the newly launched ZMLP is charging now. Also, AMLP has some significant concentration risks in its top 10 holdings.

And when it comes to dividend yield, ZMLP might steal the show in the space because only one product Cushing MLP High Income Index ETN (MLPY) provides a better yield at 7.46%.

Apart from MLPY, at present no other MLP product can beat the yield of ZMLP. So, it is pretty clear that the new Direxion product will be contending its peers primarily on yield and to some extent on price and equal-weight strategy (read:High Dividend ETFs to Buy Even If the Fed Tapers).

Bottom Line

We expect the segment and the newly introduced fund to hold up well in 2014. Investors worrying about rate hikes should note that the Fed’s decision for a further taper in 2014 will depend on whether inflation and employment perk up at a desired pace.

That means that a gradual interest rate rise in a modestly inflationary environment may not prove that bad for the rate-sensitive sectors, suggesting that investors may want to take a closer look at this interesting corner of the market for picks in 2014.

This article is brought to you courtesy of Eric Dutram.

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