Acronym Soup: Income With MLP ETNs

With their high-dividend yields and perceived lack of correlation of to oil prices, master limited partnerships (MLPs) and their corresponding exchange-traded products have been favored destinations for income investors for several years of historically low interest rates.

However, MLP exchange-traded funds and exchange-traded notes (ETNs) have defied the conventional wisdom that the asset class can remain sturdy even as oil prices slide.

MLPs And Equity-Based Energy ETFs

In fact, many of this year's worst performing equity-based energy ETFs are MLP funds. After shedding a third of its value in the past six months, the JPMorgan Chase Capital XVI JP Morgan Alerian MLP ETN (NYSE:AMJ), the largest MLP ETN, is among that ominous group.

AMJ differs from traditional ETFs in that it is treated as a debt instrument and its credit-worthiness is backed by that of the issuing bank. Fortunately, JPMorgan Chase & Co. (NYSE:JPM) is one of the most financially sound large U.S. banks.

Another issue with ETNs is limited creations, which can have significant impact on investors' buying and selling prices.

ETNs Versus ETFs

An exchange-traded note, or an ETN, is really a debt security issued by an investment bank. In the way they are structured, they perfectly replicate their index. There is no what's called 'tracking error,' where you need to worry about differences between the index and the underlying security. There is a perfect replication and, as a result, the performance tracks the index perfectly, said Morningstar in a recent note.

AMJ And Its Index

AMJ, which is more than six and a half years old, follows the Alerian MLP Index. As of the end of the second quarter, two stocks Enterprise Products Partners L.P. (NYSE:EPD) and Energy Transfer Partners LP (NYSE:ETP) combined for over 27 percent of the index's weight.

Other top 10 holdings include Magellan Midstream Partners, L.P. (NYSE:MMP) and Plains All American Pipeline, L.P. (NYSE:PAA).

The ETNs are subject to a maximum issuance limitation of 129,000,000 ETNs, which may cause the ETNs to trade at a premium relative to the indicative note value. Investors that pay a premium for the ETNs could incur significant losses if that investor sells its ETNs at a time when some or all of the premium is no longer present. We issued the remaining 11,050,000 ETNs authorized for issuance on June 19, 2012, according to JPMorgan.

Or, as Morningstar puts it, AMJ's capped creations have left the ETN functioning like a closed-end fund.

AMJ's rival, the ETRACS Alerian MLP Index ETN (NYSE:AMU), tracks the same index as AMJ, but the latter has not limited creations as of yet. AMJ has trailing 12-month dividend yield of nearly 7 percent and a standard deviation of 20.3 percent.

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