The Alerian MLP ETF's Dirty Little Secret _AMLP_ September 25th

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The Alerian MLP ETF's Dirty Little Secret _AMLP_ September 25th Powered By Docstoc
					The Alerian MLP ETF’s Dirty Little Secret (AMLP)
September 25th, 2010

                   $128 million can’t be wrong – or can it? Since its
launch on August 25, 2010, the Alerian MLP ETF (NYSE:AMLP)
has attracted an impressive amount of assets, nearly $128 million
in less than a month. However, shareholders appear to be
oblivious to the fact that AMLP employs a 62.5% daily
leverage factor, thereby giving shareholders a 37.5% daily
Upon its arrival, AMLP was heralded by scores of analysts as the
best way for investors to gain access to the performance of
Master Limited Partnerships, more commonly referred to as
MLPs. My voice was a lonely one, telling investors to beware
because I believed the marketing materials were misleading and
AMLP’s structure would make its performance fail to meet its
My original analysis was published in “Beware of MLPs in ETF
Wrappers: AMLP” dated August 27. In it, I alleged the corporate
tax structure chosen by AMLP would be a hindrance to its
performance versus the “pass-through” structures of other ETFs
and ETNs. I also argued the marketing materials were misleading
because they claimed AMLP would track the underlying Alerian
MLP Infrastructure Index before fees and total expenses of
0.85%. There was no accounting for the 35% corporate tax
Representatives from both Alerian and ALPS contacted me
regarding the story and ALPS (the fund’s advisor and distributor)
eventually provided a written response on August 30. I published
“ALPS Responds To AMLP Article” on September 3. I do not
believe they adequately addressed any of the concerns I raised,
but I will let you read it for yourself and draw your own
Part of their reply included the assertion that MLPs packaged
inside an ETF had long eluded many financial institutions that had
“been trying for years to unlock the secret to an [MLP] ETF, long
before the ETN ever came out… fortunately, MSSRS Hammond
and Feng [Alerian executives] finally figured out the key to the
ETF structure”.
I have figured out the secret too: AMLP’s daily NAV is
calculated with a 62.5% leverage factor.
First of all, investors must understand that when tracking an
index, all ETFs employ leverage.   In the vast majority of cases
the leverage is 1x (or 100%) and the ETF seeks to track 100% of
the daily change of the underlying index. Many investors tend to
think of ProShares and Direxion when the subject of leveraged
ETFs is brought up, as those two sponsors provide many of the 2x
and 3x leveraged products on the market.
However, leverage can also be less than 100%. In the case of
AMLP, the fund’s market value is based on 100% daily leverage
while the fund’s NAV calculation (what the shareholder sees) uses
62.5% leverage and seeks to track 62.5% of the daily change of
the underlying index. This fact does not appear to be disclosed
anywhere to shareholders: not in the AMLP prospectus (pdf), not
in the Statement of Additional Information (pdf), and certainly
not in the marketing materials.
The fund’s custodian, Bank of New York Mellon (BNY), is
responsible for the daily calculation of the NAV and has
apparently been informed about the daily leverage factor it
should apply to its calculations.
In my original article, I stated the “Total Expense Ratio” of
0.85% appears to be misleading since it did not account
for any of the 35% corporate tax impact. It now appears
that “misleading” was much too soft of a word because the
real expense ratio is closer to 0.85% plus 37.5% of the
daily movement of the underlying index. Anyone can verify
this by comparing the daily change of the Alerian MLP
Infrastructure Index to the daily change of AMLP. Note: the
typical daily factors for AMLP range between 59% and 66%. I am
using 62.5%, with a 37.5% reciprocal, based on information
supplied in the response I received from ALPS. Contrarily, the
website states “a tax expense of 0.00% has been assumed since
it cannot be predicted whether the Fund will incur a benefit or
liability in the future.” Seems to me they think it will be 37.5% of
the daily change.
After less than a month of trading, the 37.5% daily clipping has
added up to $1,026,353.10 as of 9/22/10. This figure is derived
by subtracting AMLP’s net asset value (what shareholders own) of
$127,764,948.39 from the $128,791,301.46 market value (value
of securities held). You can calculate the current difference using
the data as listed on the performance page of the website. The
0.8% difference also happens to equal to AMLP’s performance lag
and amounts to a huge increase in the effective expense ratio .
If I were a shareholder, I would want to know where the
other 37.5% of my promised gains went. Those profits are
supposedly being held back to pay AMLP’s corporate
taxes. AMLP is touting its tax efficiency while at the same
time clipping shareholders 37.5% of the daily movement
for tax reasons. Now tell me again how the ETF structure
is superior – especially for investors wanting to hold AMLP
in an IRA like the marketing materials suggest.
As I alluded to in my original article, I don’t think the
current shareholders understand what they bought, and
now that misunderstanding has reached a level of $128
million. Who is to blame for this? I’m sure some will point
their finger at the SEC saying it should not have approved
this ETF. However, if the SEC only saw the prospectus and
SAI, maybe they didn’t know about the 37.5% daily
clipping factor either.
Representatives from ALPS and Alerian discussed this article with
me under the condition that I not quote them and not use their
names. Both confirmed the daily NAV change calculation is
reduced by about 37.5% from the daily index change calculation.
ALPS and Alerian maintain that AMLP will still deliver superior
long-term after-tax results when held in a taxable account. The
taxation of MLPs is a difficult subject, so perhaps that is true, but
I have trouble understanding how it is possible when AMLP is
taking a 37.5% daily hit up front.
Written By Ron Rowland From Invest With An Edge

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