MLP ETN Up 19%: Pros And Cons Of Buying Now

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Master limited partnerships, which typically run toll-road-type businesses transporting, storing and processing oil and gas, have exploded this year.

They could be this year's big catch-up play after lagging the market last year. And if history repeats, they offer a compelling source of dividend income in a rising interest rate environment, analysts say.

JPMorgan Alerian MLP Index ETN ( AMJ ) popped 18.7% year to date vs. 9.7% for SPDR S&P 500 ( SPY ).Energy Select Sector SPDR ( XLE ), tracking the oil and gas producers in the S&P 500, added 9.0% year to date.

ALPS Alerian MLP ETF ( AMLP ), the most widely traded MLP ETF, rose 10.5% year to date. In 2012, AMJ climbed nearly 4%, while SPY surged 16% and AMLP gained 2%.

AMJ and AMLP both track the same underlying indexes. Their returns differ because of their fund structures. AMJ is an exchange traded note, which is basically a company IOU designed to track the underlying index.

Investors do not actually own the underlying stocks and must rely on the issuer to make good on its debt obligations. Changes in the issuer's credit ratings could affect the ETN's value. AMJ takes 0.85% of assets as an annual fee. It has a 12-month yield of 4.6%.

AMLP is structured as a regular corporation rather than a mutual fund like most ETFs . It has to pay federal income taxes, which get passed on to AMLP investors as a "deferred income tax expense."

That now comes to 4.01%. So on top of the 0.85% annual management fee, AMLP's total expense ratio amounts to 4.86%, making it the most expensive ETF by far. Its 12-month yield is 5.72%.

The largest names in the Alerian MLP Index includeEnterprise Products Partners ( EPD ),Kinder Morgan Energy Partners (KMP),Plains All American Pipeline (PAA),Energy Transfer Partners (ETP) andEnergy Transfer Equity (ETE).

MLPs could return as much as 25% this year, according to Credit Suisse analysts. "MLPs remain well positioned to benefit from what will likely be a sustained increase in North American crude oil, natural gas and NGL (natural gas liquids) production over the next decade," Credit Suisse analysts wrote in a report.

"With much of this incremental production coming from unconventional sources, the demand for energy infrastructure, specifically midstream infrastructure such as pipelines, processing facilities and storage, should trump the potentially negative impact of higher interest rates," the analysts added.

They believe interest rates will rise because the Federal Reserve will eventually have to curb its quantitative easing program, sending 10-year bond yields to normal historical levels in the 2% to 3% range.

Yields on 10-year government bonds started the year at 1.86%, climbed to 2.07% in mid-March and have since fallen to 1.76%. Major dividend-paying sectors outperformed the market under that rare condition in the past.

From June 2004 to June 2007, when the Fed's target rate climbed from 1.25% to 5.25%, real estate investment trusts, utilities and MLPs all outpaced the S&P 500. In the three-year period, utilities returned a compounded 24%, REITs 20% and MLPs 19% vs. 11% for the S&P 500, Credit Suisse wrote. High-yield bonds returned 9% while investment grade bonds added 4%.

"The key MLP advantage over bonds is the potential for distribution increases and the equity component, which gives the investor a degree of inflation protection," Credit Suisse wrote.



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 , EPD , SPY , XLE

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