AMJ At A Premium, But Will It Last?

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(Updated to reflect that AMJ's share price is now trading at premium to NAV, and that some sources believe investors may be willing to pay a premium for AMJ in exchange for its high liquidity.)

Investors-it looks like one investor-poured $407.9 million into the JPMorgan Alerian MLP ETN (NYSEArca:AMJ) last week, a development that lifted AMJ's outstanding float to the 129 million-share ceiling set a week ago by the note's sponsor, J.P. Morgan Chase and brought the ETN to the brink of trading at a premium.

The huge ETN has since moved into a premium to its net asset value -- 2 percent above NAV on Wednesday morning and ending at a 1.2 percent premium to NAV on Tuesday, June 26. But will the premium have staying power?

It's certainly possible. There are now 129 million AMJ shares issued, and that is indeed the limit that the biggest U.S. bank by assets set last week.

But of possibly critical importance, J.P. Morgan said on its website that it was holding about 11 million AMJ shares in its own inventory as of late last week. That means that J.P Morgan itself is probably behind the big creation, and that fewer than 129 million AMJ shares are publicly held. However, that number in inventory has fallen in past few days by more than 40 percent, meaning investors are snatching up AMJ shares.

AMJ, which focuses largely on energy-related master limited partnerships such as pipelines, has grown in size rather quickly because it's paying a hefty dividend at a time when official short-term interest rates are near zero. AMJ ended Wednesday's session with $4.76 billion in assets, or 30 percent more than at the end of 2011, according to data compiled by IndexUniverse.

AMJ trading at a closed-end-fund-like premium to NAV recalls the fate of the VelocityShares Daily 2X VIX Short-Term ETN (NYSEArca:TVIX). TVIX's sponsor, Credit Suisse, halted creations in February, and TVIX quickly began trading at a premium until creations were partially resumed a month later.

The whole episode left a bad taste in some investors' mouths, which led us to write a piece about it titled "Did The TVIX News Leak?" when the premium evaporated even before the official news of resumed creations was completly public. The TVIX affair thus makes us wonder just what J.P. Morgan plans to do with all those shares.

On a guardedly positive note, speculators pushing AMJ to a premium could make the ETN's current holders quite happy.

An AMJ premium could also be a boon for the other eight competing MLP ETNs listed in the U.S. that you can find on IndexUniverse's "Fund Finder."

Additionally, it could also help the growing number of MLP ETFs that don't run the same risks as ETNs in terms of imposing share-creation limits.

The biggest of those competing ETFs, the Alerian MLP ETF (NYSEArca:AMLP) has $3.31 billion in assets. AMLP has thrived in spite of downside tax consequences ETNs don't have.

What's J.P. Morgan's Plan?

So, the question is:What does J.P. Morgan plan to do with those 11 million shares? The big bank isn't talking-apart from the press release it put out on June 14 announcing the 129-million-share limit and apart from the updates it provides on its website.

J.P. Morgan could keep releasing shares of AMJ to the market to meet demand and to help keep a premium from developing, or at least developing too quickly.

Some industry sources suspect that's exactly what J.P. Morgan will do, likening the process to doing creations, but in the secondary market.

But will the bank wait for a premium to build before releasing those shares? The fact that AMJ has been trading at a premium since last Friday isn't an encouraging sign.

Still these sources don't think J.P. Morgan will be looking to cynically exploit a premium in the name of raising trading profit. Moreover, they think some investors think paying for AMJ at a slight premium might be worth it considering the ETN is so liquid and trades with such tight bid/ask spreads.

More broadly, they argue that managing an ETN as big as AMJ-it's assets amount to a about quarter of all U.S.-listed ETN assets-all-but requires the bank to keep the security operating as advertised, lest it become the latest poster child for suspicious and self-serving behavior on Wall Street. That's all the more true given the $2 billion "London Whale" issue the bank is facing now.

But even if J.P. Morgan works to ethically and carefully manage the possibility of a premium developing, that doesn't mean a premium in AMJ won't eventually develop once those 11 million shares in inventory get used up. The fact that the ETN is at a premium reflects the possibilty that the market considers a premium inevitable, given the brisk demand for the security in the past few years.

If AMJ does start trading at a premium, that's probably great news for competing MLP ETNs and ETFs aren't identical to AMJ, but they're close enough to serve a similar purpose to investors looking for more nuanced equities-like exposure in their portfolios. That's particularly true of the ETNs, which have the same tax treatment as AMJ.

Whether J.P. Morgan ever resumes creations is anyone's guess, but it's a question that on anyone's mind who's watching this AMJ scenario play out.

Risk Management

Industry sources say J.P. Morgan imposed the 129 million share limit to make management of the security a finite task-the scope of which could be fully grasped by both investors and the ETN's managers at all times.

A trading desk facing mounting hedging tasks as an ETN grows rapidly could lose control of risk management mechanisms-a concern that was widely voiced at the time Credit Suisse halted creations of TVIX in February.

Whatever validity to Credit Suisse's concerns, as noted, the whole episode gave a lot of people pause. The takeaway is that investors need to pay attention.

Investors should monitor AMJ for any divergence from its NAV by staying on top of how quickly that 11-million-share buffer is shrinking by checking out J.P. Morgan's website regularly. (Click on the PDF that says "Daily Report" to get a running total of just how many AMJ shares the company is holding.)

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: AMJ , AMLP , TVIX

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