When it comes to tracking the master limited partnership market, investors need to pay attention to which benchmark they pick.
Master limited partnerships often own and operate pipelines for natural gas and oil, an area of rapid growth in investment. Stakes in these companies are publicly traded and their distribution rates, recently around 6%, have tantalized investors in the past few years. As a result, financial companies have recently launched a slew of retail vehicles to target these holdings.
While these new investments present a range of thorny tax issues, the handful that are designed as index trackers, rather than actively managed open- or closed-end funds, present one additional wrinkle: their indexes can differ significantly.
Despite similar looking names, the two most popular MLP exchange-traded securities, the $2.7 billion JPMorgan Alerian MLP Index exchange-traded note and the $1.1 billion ALPS Alerian MLP ETF, track different versions of an MLP benchmark calculated by the Dallas company Alerian.
The exchange-traded note, an unsecured debt security issued by JPMorgan Chase & Co., focuses on the broader, slightly older version of the index that launched in 2006 and which is known simply as the Alerian MLP Index.
The bulk of this 50-member index, representing about four-fifths of its weight, is in oil and natural gas transportation and storage master limited partnerships. By contrast, the ETF focuses on a newer, narrower version, the Alerian MLP Infrastructure index, a benchmark made up of just 25 names that excludes the smaller fifth of the market that the fund's creators felt many MLP investors were less interested in.
Counterintuitively, the narrower infrastructure version is more broadly diversified, at least in one sense: It uses a complex formula to cap the weight of its largest holdings.
The change means that, among other things, Enterprise Products Partners LP, the largest holding in both indexes, represented 14.5% of the broader version at March 31, but only 9.6% of the narrower infrastructure version.
Another result of the tweaks that created the narrower version is better long-term returns, at least in theory. While neither index is very old, index creators typically calculate "back-tested" returns to give investors a flavor for how an index would have fared in past markets. By this hypothetical measure, the narrower infrastructure version posted average annual returns of 20.3% over the past decade through March 31, compared with 17.3% for the version that represents the market as a whole. The difference between the two indexes' actual returns over the past three years — the longest standard period during which both have been published — is much smaller, however, 20.6% vs. 20%.
