The Holy Grail for Yield-Hungry Investors

 | Apr 09, 2012 | 11:00 AM EDT  | Comments
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mlpl

The recent jobs and Fed concerns after a superb first quarter are disappointing for several reasons. Beyond the immediate sea of red that will be washing over account statements, it means that the time horizon for interest-rate hikes is pushed a bit further down the road. That's unsettling news for investors who have seen the traditional sources of current returns dry up for the better part of two years, with no sign of returning (pardon the pun) anytime soon.

I find myself writing quite a bit about securities that offer a way for investors to capture a little bit of yield, because that objective has become more challenging than ever at a time when distributions have become no less important. It has forced investors of all types to get creative in their quest for an attractive stream of current income. And more often than not, the hunt for yield has involved a shift towards the uncomfortable end of the risk spectrum.

For most investors setting out to bulk up the current returns portion of their portfolio, accomplishing this objective involves a fairly significant upgrade in total risk. Many have shifted allocations from Treasuries and investment-grade corporates to junk bonds and euro-denominated debt. Others have gravitated towards more speculative stocks that offer bigger dividend opportunities, taking on additional risk in the process.

A recent addition to my portfolio is an ETN that I think offers a big upgrade in yield without a huge amount of incremental risk: the UBS 2x Leveraged Long Alerian MLP Infrastructure ETN (MLPL). This note currently has a distribution yield that is close to 10%, along with a level of volatility that is on par with the S&P 500. I've had a significant portion of my portfolio for the last couple of years devoted to MLPs, a corner of the domestic energy market that benefits from some unique tax treatments and is able to make some huge payouts. I've now added MLPL as a way to ramp up the dividends with a smaller amount of risk than many investors would expect from this type of product.

At first blush, MLPL probably seems way too risky for most portfolios. A lot of investors see the word "leveraged" and run as fast as they can in the other direction, spooked about horror stories for those who have held these products over extended periods of times and been whipsawed by the adverse impact of compounding returns. Of course, any type of leverage creates a step up in risk that leads to greater potential for losses on the downside. But it's important to note that monthly leverage is drastically different from daily leverage. The frequency with which exposure resets has a major impact on the volatility of an investment and suitability for investors. MLPL seeks to achieve its target amplification multiple (2x) over the course of a calendar month, which drastically reduces the potential for the adverse impacts that erode returns to daily leveraged products over the long haul.

There's also a misconception about the general level of risk associated with MLPs, which often own pipelines that transport and store natural gas and petroleum products. Despite the close association with energy commodities, MLPs are actually not all that sensitive to prices of these resources. Fluctuations in gas prices don't really impact the revenues earned by MLPs. As long as people need oil to move from point A to point B there will be a need for MLPS, regardless of whether gas costs $5 or $2 a gallon.

All this is a long way of saying that there is a disconnect between investors' expectations of risk for MLPL and the economic reality. It's an ETN that yields more than 9% and features about the same recent historical volatility as SPY, a combination of high yields and relatively low volatility that is the Holy Grail in the current environment.

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