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Summary The InfraCap MLP ETF is one of the new, actively managed ETFs, bringing return-enhancement strategies to the ETF space. MLP-focused funds face additional tax hurdles not faced by ETFs in other market sectors. The InfraCap fund strategies may help overcome those hurdles. The investment results from the new MLP can be directly compared to the largest MLP ETF, allowing investors to see if the active management strategies work. A new MLP-focused ETF, InfraCap MLP ETF (NYSEARCA: AMZA ) takes an interesting approach to offsetting the rather large hurdles facing an ETF that tracks the widely followed Alerian MLP Infrastructure Index – AMZI . Since AMZA is based on the index tracked by the largest MLP-focused ETF, results from the ETF can be directly compared. Challenges for an MLP ETF Several features of MLPs and the MLP indexes provide distinct challenges for an ETF that wants to mimic the returns of a specific ETF. These challenges result in significant underperformance by the ETF compared to the index or a well-selected basket of individual MLPs. Tax rules concerning investment funds and MLPs provide the biggest drag on returns. A fund that holds more than 25% of its portfolio in MLPs is forced to structure as a corporation and pay corporate income taxes on net income reported by the owned MLP units. A fund organized as a corporation will also adjust its calculated NAV for an accrued, deferred income tax liability. The result is an NAV that lags the index value gains by the 35% top corporate income tax rate. A second challenge for an Alerian index focused ETF is the structure of the AMZI index. The index includes just 25 midstream MLPs, with the five largest partnerships – Enterprise Products Partners, L.P. (NYSE: EPD ) , Magellan Midstream Partners, L.P. (NYSE: MMP ) , Plains All American Pipeline, L.P. (NYSE: PAA ) , Energy Transfer Partners, L.P. (NYSE: ETP ) , and MarkWest Energy Partners, L.P. (NYSE: MWE ) – accounting for 41% of the index value. The result is just a few large MLPs – good or bad – have an over-weighted impact on the index results. Benefits of an MLP Focused Fund Before jumping into the discussion about the AMZA ETF, here are a couple of reasons to use an MLP ETF as a way to get exposure to this historically high-yield, high-average total returns sector: A fund turns the MLP K-1 reporting tax hassle into a simple 1099 reporting investment. Typically, MLP fund dividends are a combination of non-taxable return of capital and ordinary income. A fund may be a better way to get MLP exposure inside of a tax-advantaged account such as an IRA. Owning MLP units inside of an IRA can produce additional tax reporting and tax payments out of the tax-deferred account. The corporate income tax accrual has the additional effect of increasing the yield of an ETF compared to the index. While the AMZI currently yields 5.74%, the tracking ETF yields 6.81%, even with 0.85% in expenses. InfraCap MLP ETF Active Management Adjustments to AMZI According to its prospectus , the InfraCap MLP ETF typically owns the same 25 midstream MLPs tracked by the AMZI index. However, the ETF’s active management strategy allows management to use any or all of the following strategies to boost returns or safeguard against declines. Underweight and overweight MLPs compared to the AMZI based on Infrastructure Capital Advisors proprietary model that values MLPs based on commodity prices, cash flow forecasts, and relative valuations. Fund management will sell call options to enhance the yield earned by investors. AMZA can employ up to 33.3% leverage. The use of leverage provides an offset to the corporate income tax bite. Management can reduce leverage or even move into cash if the model determines the MLP sector is overvalued. The bottom line is that with AMZA, investors get a strategically managed MLP ETF with an expense ratio of just 0.95%. This is significantly less than the typical expenses of an MLP-focused closed-end fund (which also incurs the corporate income tax bite) and the 0.85% expenses of the $9 billion in assets ALPS Alerian MLP ETF (NYSEARCA: AMLP ) . AMLP tracks the Alerian MLP Infrastructure Index. Since AMLP tracks the AMZI index and AMZA holds the same components weighted by its model, it will be interesting to see if the active management strategies produce extra return for investors. AMZA was launched in October 2014 and has gathered $7 million in assets. So we have two questions: Will the active management model work? And will investors buy into it? Scalper1 News
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