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Quality Matters When Considering Yield-Generating MLP ETFs

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While the ALPS Alerian MLP ETF (NYSEArca:AMLP) has recently announced a lower distribution, the revised dividend payout is not a cause for concern. The underlying cause for the changes may actually benefit investors in the long-run.

AMLP is the largest master limited partnership-related ETF available, with close to $8 billion in net assets under management, which means that a lot of MLP investors are looking at the fund to gauge the sector. Consequently, some investors may be surprised by the sudden dividend decrease to $0.240 per share at its latest distribution.

However, "don't misconstrue lower yields a negative," Jeremy Held, Director of Research at ALPS Advisors, told ETF Trends in a call, pointing out that no underlying components cut their distributions.

Related: Downtrodden MLP ETFs May Offer Long-Term Opportunity

Held explained that lower yields in the MLP space can occur for a variety of reasons, some of which are actually a sign of health in the sector: First off, yields fall as prices rise, and MLPs have been rebounding along with the oil prices and the broader energy sector - AMLP has surged 52.9% since its February 11 low. Secondly, the yield can go down due to changes within the underlying benchmark index - AMLP tracks the Alerian MLP Infrastructure Index, which includes 24 pipeline and processing MLPs.

"The yield on an MLP index can also fall due to rebalancing and reconstitution in the index. Alerian uses a strict index methodology which requires that only larger, higher quality companies are retained in the Index," Held said.

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The rebalancing and reconstitution may be beneficial for investors as it helps to potentially eliminate high-stress MLPs and replace them with higher quality options. However, riskier MLPs also come with higher yields, so the change up can reduce overall yields for investors in exchange for greater stability.

Specifically, the underlying Alerian Index removed two MLPs in its most recent quarter. Targa Resources Partners (NYSE: NGLS) was acquired by its parent company, Targa Resources Corporation ( TRGP ). In addition, the Index eliminated NGL Energy Partners ( NGL ) due to market capitalization requirements. Both MLPs were yielding more than 30% at the time of their removal from the Index.

"We believe that stringent indexing requirements help investors in the long run," Held said. "Higher quality names have historically performed better in a tough economic environment and have a track record of better distribution stability."

Related: Master Limited Partnership ETFs Are Back on Trend

In keeping with its quality focus, the underlying index is made up of about 86% investment-grade MLPs. By contrast, there is not a single investment grade MLP outside of the Index.

The MLP ETF includes a group of dividend growing partnerships. Held pointed out that the underlying names in AMLP grew their distributions at a faster rate last quarter for the third quarter in a row. As witnessed in other areas of the market, dividend growth stocks and ETFs have outperformed in the long run, whereas dividend cutters have historically underperformed. AMLP outperformed many other MLP-related exchange traded products for the past year and 3-year periods.

"We think, at the end of the day, MLP investors are interested in owning the best combination of both quality and yield for their portfolios," Held added.

Based on the May 10 price, the indicated yield for AMLP is 8.05%, which still ranks among the top half of all MLP funds.

For more news on MLPs, visit our MLP category .

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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

This article was provided by our partner Tom Lydon of etftrends.com.


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

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