By Todd Rosenbluth, CFRA
ETF investors can now get the potential growth benefits of sector investing, with the potentially complimentary income investing of mid-stream energy master limited partnerships (MLPs) from a well-established asset manager. A suite of four Cushing Sector Plus ETFs offering a twist on the sector investing world started trading Thursday.
Sector investing through ETFs has been around for 20 years, with the large-cap focused Select Sector SPDRs offered by SSGA remaining the largest and most frequently traded of the bunch. Yet, investors also have turned to sector or industry ETFs that are multi-cap focused, equally weighted or fundamentally constructed. Even a few intentionally blur the lines between sectors rather than rigidly adhering to the GICS structure. Yet, these new products from Cushing are interesting to CFRA because they combine a fundamental sector/industry approach with the income benefits of MLPs in a tax-friendly manner.
According to Stewart Glickman, an equity analyst at CFRA, the mid-stream energy business revolves around moving hydrocarbons from point A to point B, and mid-stream providers receive a per-unit fee for doing so. Companies such as Enterprise Products Partners (EPD 26 ****) and Magellan Midstream Partners (MMP 60 *****) essentially act as toll-collectors, and as such, the volume of barrels of crude oil being moved is generally more important than the crude oil price. Both EPD and MLP sport dividend yields above 6%, which combined with their fundamental and valuation attributes, makes them attractive to CFRA.
Some MLP ETFs, such as Alerian MLP ETF (AMLP 10 NR), hold more than 25% of their portfolio in MLPs that are structured as C-Corporations and must pay corporate income tax on distributions before passing them on to investors. Doing so results in additional tax-related headaches. However, other MLP-oriented ETFs, such First Trust North American Energy Infrastructure (EMLP 23 Marketweight) are structured as traditional funds but can’t hold solely MLPs to avoid the receipt of schedule K-1s come tax time. Rather, EMLP also holds non-MLP pipeline companies and utilities, such as TransCanada (TRP 41 ****) and Exelon (EXC 47 *****).
The new Cushing ETFs will also limit the exposure to MLPs to 24% at each quarterly rebalance. Stocks such as EPD, MMP and other mid-stream companies in the firm’s proprietary Cushing 30 MLP index are combined with a yield-weighted sleeve of stocks from prominent sector or industry benchmarks offered by S&P Dow Jones Indices.
For example, using index data, CFRA thinks Cushing Energy & MLP ETF (XLEY) will initially hold larger stakes in higher-dividend yielding Kinder Morgan (KMI 17 ****) and Williams Companies (WMB 25 ***) than Exxon (XOM 79 ***) and Chevron (CVX 117 ****); XOM and CVX were a combined 43% of assets for Energy Select Sector SPDR (XLE Overweight) at the end of November.
However, there are no MLPs in the S&P 500 Energy index, so the inclusion of EPD, MMP and others provides mid-stream exposure and an income component to a large-cap energy strategy. While past performance is not indicative of future results, year-to-date through September, the index behind XLEY outperformed the S&P Energy Sector index by approximately 600 basis points.
Meanwhile, we think the thematic orientation of Cushing Transportation & MLP ETF (XLTY) and Cushing Energy Supply Chain (XLSY) is worthy of attention. Most of the thematic ETFs to come to market in recent years and have success are tech related, but XLTY and XLSY focus on the energy space.