What is an MLP?
Master Limited Partnerships (MLP’s) are a good example of unique investment vehicles which can offer market participants certain benefits traditional products such as equities and bonds may not always provide. To begin, let’s start by giving a brief background on MLP’s and how they are structured. By definition, a master limited partnership (MLP) is a business organization that exists in the form of a publicly traded limited partnership . There are two classes of partners within an MLP: limited partners and general partners. Limited partners purchase units in the MLP which provide capital for the day-to-day operations. This also allows them to receive periodic cash distributions that are typically paid out on a quarterly basis. General partners are responsible for managing the day-to-day operations and are compensated based on the performance of the business. Gaining access to an MLP is fairly easy as they can be purchased through an exchange or over the counter like most common stocks. They are most often organized by energy firms that are involved in the oil and gas industry that deal in pipelines and storage.
One of the major advantages MLP’s provide to investors is the periodic income stream (due to the quarterly cash distribution and high dividend yields). Due to their structure, MLP’s also provide investors with nice tax advantages. For example, MLP’s are not taxed at the corporate level. Instead, each unit holder is taxed on his or her portion of MLP earnings which helps avoid the double taxation most corporations must pay. One of the main risks involved includes declining energy prices which eventually could force an MLP to cut its dividend. One way to avoid this company specific risk is by investing in an ETF or ETN comprised of a number of MLP’s to diversify holdings beyond one organization.
Investors are now able to gain exposure to multiple MLP’s through a new ETN that was launched by BMO and Elkhorn. The BMO Elkhorn DWA MLP Select Index Exchange Traded Note (Nasdaq: BMLP) launched on 12/20/16 and tracks the Dorsey Wright MLP Index (DWAMLP). The index was launched on 05/01/2015 and follows the Dorsey Wright Relative Strength based methodology. It is rebalanced on a monthly basis and will continue to be allocated towards the strongest performing members of the universe.
Dorsey Wright MLP Index (DWAMLP)
Methodology & Security Selection
- Index Holdings must have minimum market capitalization of $1 billion
- Index Holdings must have one month average daily dollar trading volume of $2 million per day on primary exchange
- Index follows the Dorsey Wright Relative Strength Ranking Methodology
- Index universe consists of all MLP’s that are not classified as Financials according to the Industry Classification Benchmark (ICB)
- Index holds the top 15 ranked securities within the universe that meet all minimum market cap and liquidity thresholds
- Index is rebalanced on a monthly basis
- Index is equal-weighted
The table below lists the top 10 holdings (in terms of allocation size) currently in the index as of 12/30/16. Note the high dividend yields which correspond with the majority of the holdings in order to help generate income. The largest dividend yield comes from Crestwood Equity Partners (CEQP), which stands at 12.43%.
Since its launch, DWAMLP was up 3.74% on a total return basis (as of close on 12/30/16). This compares quite favorably to the Alerian MLP Index (AMZ) which was down -20.75% over the same time period. We’ve also included performance of two other Nasdaq Energy related benchmarks to give additional color from a performance perspective. The Nasdaq Commodity Crude Oil Index ER (NQCICLER) (an index comprised of front month WTI Crude Futures) was down -40.07%, and the Nasdaq US Oil & Gas index (NQUSB001) (an index comprised of equities that are classified as Oil & Gas according to ICB) declined -10.85%. The difference in performance helps display the benefits of the relative strength based methodology which the index follows. Staying allocated towards the stronger performing members of the universe helps diversify risk away from those securities which are underperforming.
Digging into our performance analysis a bit further we can look at the below chart and notice the steep declines seen by much of the energy sector during May 2015-Feb 2015. DWAMLP bottomed out on 2/11/2016 and has since rebounded an impressive 76.06% into the end of the year.
Below we can see the max draw-down statistics for each of the four indexes. This is often an important factor to consider given the effect severe draw-downs can play in terms of investor sentiment. DWAMLP follows a strict relative strength based investment methodology which helps keep human emotion to a minimum in terms of selecting which securities are included in the index.
The annualized volatility for DWAMLP since inception is 29.22%. This is lower than both AMZ (34.05%) and NQCICLER (43.73%), but slightly higher than NQUSB0001 (25.58%). Using these figures we can then calculate the annualized Sharpe Ratio to analyze risk-adjusted returns. The annualized Sharpe for DWAMLP during the allotted time frame was 0.06 while AMZ’s figure was -0.40. Given the negative returns experienced in the MLP space back a year and a half it’s not surprising to see the lower Sharpe ratios across the board. Further, the performance gap and simultaneous lower volatility by DWAMLP vs the benchmark can both largely be attributed to the underlying momentum strategy which DWAMLP follows.
Beta & Correlation Analysis:
Another way to look at the systematic risk of an investment vehicle is calculating its “Beta” when compared to an allotted benchmark. This figure represents how a security responds to swings in the market. In this case, we’ve shown a number of comparisons all of which display a lower beta for DWAMLP when compared to the energy related indexes we’ve discussed above.
Table below confirms very high correlation to the benchmark and strong correlations to oil & gas equities and slightly lower to the WTI futures.
MLP’s are a great way to invest in the markets when searching for yield given their structure. They generally tend to be organizations that are involved in the energy markets and naturally have high correlations and betas to that market from an equity and futures perspective as can be seen above. The Dorsey Wright MLP Index (DWAMLP) selects the top 15 non-financial MLPs each month based upon relative strength and equal weights them. Coupling the Dorsey Wright relative strength selection with the equal weight methodology has resulted in historical outperformance over, and lower volatility than, the benchmark.
The recent ETN launch between BMO and Elkhorn (Nasdaq: BMLP) is the first entirely MLP-based ETP linked to a Nasdaq Index and tracks the Dorsey Wright MLP Select Index (DWAMLP).
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