ETFs and MLPs, Handy for Do-It-Yourself Funds

Create Your Own MLP Fund For Higher Returns

Buying small positions in several high yielding MLPs can be more profitable than investing in an MLP ETF or ETN. After adjusting for management fees, the net return of ETF and ETNs is considerably lower than the highest yielding MLPs. This chart lists some of the most popular MLP ETFs and ETNs with their management fee subtracted from the yield:

MLP ETF/ETN Mgmt. Fee Yield Yield minus Fee
Alerian MLP ETF (AMLP) 0.85% 6.4% 5.55%
Tortoise Energy Capital ETF (TYY) 0.95% 6.5% 5.55%
Cushing 30 MLP Index ETN (MLPN) 0.85% 7% 6.15%
UBS E-TRACS Alerian MLP ETN (MLPI) 0.85% 5.3% 4.45%


In addition to lower yields, MLP ETFs do not appear to offer the same level of safety as other sector ETFs. Tortoise (TYY) declined 70% from its 2007 high during the 08-09 recession. Aside from Alerian, the volume is considerably lower for MLP ETFs than MLPs themselves. ETNs have their own set of risks due to their unique credit structure.

The primary safety feature of ETFs is diversity. Buying several small positions rather than one or two large positions, creates security and protection should something unexpected befall an individual MLP.

MLP ETFs have their purpose. Investors sitting on cash looking to generate income while waiting for better market conditions can park their money in these ETFs and collect 6% while they wait. They do not have to worry about K-1 forms and tax issues. Tax-deferred accounts cannot invest in MLPs without going through ETFs.

However, for income-oriented investors who are willing to hold MLPs for many years, creating a personalized fund of higher yielding MLPs may be more profitable. The following chart is an example:

MLP Yield
Energy Transfer Partners (ETP) 8.16%
Boardwalk Pipeline Partners (BWP) 8.32%
Kinder Morgan Energy Partners (KMP) 6.68%
Buckeye Partners (BPL) 6.5%
Plains All American Pipeline (PAA) 6.6%
Dorchester Minerals (DMLP) 7.13%
Average Yield 7.23%

Well Oiled Machine

The latest Buffett acquisition looks like another great deal for Berkshire and its shareholders. Maybe it's time to create an ETF built around the companies he's most likely to buy.

Buffett Still Gets Lubrizol at Lehman-Bust Price After 183% Gain: Real M&A

March 14 (Bloomberg) -- Warren Buffett’s Berkshire Hathaway Inc. agreed to buy Lubrizol Corp., the world’s largest producer of lubricant additives, for about $9 billion in the cash-flush investor’s second-biggest acquisition in the past five years. Berkshire will pay $135 a share in cash, 28 percent more than Lubrizol’s closing share price on March 11, the Omaha, Nebraska-based company said in a statement today.

Warren Buffett is still getting the same discount for his takeover of Lubrizol Corp. (LZ) even after the maker of engine lubricant almost tripled since the billionaire investor said it was time to start buying U.S. equities.

Berkshire Hathaway Inc. (BRK/A) will pay about $9 billion for Lubrizol in its second-largest purchase since Buffett said in October 2008 he was staking his personal fortune to American stocks. While Lubrizol surged 183 percent over that span, its equity and net debt was valued at 5.8 times earnings before interest, taxes, depreciation and amortization prior to yesterday’s announcement, according to data compiled by Bloomberg. That compares with 5.7 times when Buffett made his comments a month after Lehman Brothers Holdings Inc. collapsed.

Even with a 24 percent premium, the Ebitda multiple that Buffett is paying for Wickliffe, Ohio-based Lubrizol is still the cheapest for a specialty chemicals company in 12 years, data compiled by Bloomberg show. Lubrizol has doubled earnings and its operating margin in the past two years and controls 35 percent of sales in an industry dominated by four companies.

“Being an excellent investor means you don’t overpay,” said Brian Barish, Denver-based president of Cambiar Investors LLC, which oversees $7 billion. “It’s a pretty good deal for Buffett in terms of the kind of stuff that he tends to gravitate towards.”

Barish’s $1.44 billion Cambiar Opportunity Fund (CAMOX) has outperformed 99 percent of rival funds over the past year.

‘Major Acquisitions’

Buffett didn’t respond to a request for comment e-mailed to his assistant, Carrie Kizer. Julie Young, a spokeswoman for Lubrizol, didn’t respond to a telephone call and e-mail.

The Lubrizol deal comes two weeks after the billionaire said in his annual letter to shareholders on Feb. 26 that he was looking for “more major acquisitions,” a year after spending $26.5 billion to buy Burlington Northern Santa Fe railroad in his largest purchase.

Buffett said Omaha, Nebraska-based Berkshire, whose cash rose to a three-year high of $38.2 billion, needed more buyouts and that his “trigger finger is itchy.”

Lubrizol, the world’s largest producer of lubricant additives, was one of more than 40 companies that Bloomberg identified this month that fit criteria listed in his letter.

Buffett typically prefers “simple” businesses with pretax profit exceeding $75 million, “consistent” earning power, and “good” returns on equity while employing little or no debt, according to his report. His takeover strategy has shifted as Berkshire has grown to focus on “capital intensive businesses,” such as power producers and railroads, which require consistent investment in infrastructure and equipment.

Relative Value

Lubrizol’s capital expenses in the past 12 months accounted for 15 percent of net fixed assets, and its average price- earnings ratio over five years was 11.9, data compiled by Bloomberg show.

The maker of engine lubricant posted a return on equity of 34 percent last year, the highest for a company taken over in the specialty chemicals industry in a deal worth more than $1 billion since Inspec Group Plc in 1998, the data show.

Lubrizol also makes plastics used in pipes, auto parts and electronics; Carbopol polymer for personal-care products such as hair gel; and acrylic resins and other materials for coatings.

Berkshire is acquiring Lubrizol after its stock reached a high of $114.81 on Oct. 25, 2010. The shares climbed 183 percent from Buffett’s comments in October 2008 to $105.44 on March 11, the last day of trading before the deal was announced. Lubrizol fell 72 cents to $133.96 at 9:48 a.m. on the New York Stock Exchange after surging 28 percent yesterday.

‘Got Good Value’

“The stock has gone up a lot,” said John Carey, a Boston- based money manager at Pioneer Investments, which oversees about $250 billion. “He’s not getting it at as cheap a price as he might have. He evidently feels that it’s still got good value.”

Lubrizol’s trailing 12-month Ebitda doubled during the same period to $1.26 billion, keeping the company’s enterprise value -- or the sum of its equity and debt minus cash -- to Ebitda multiple little changed, data compiled by Bloomberg show.

Buffett wrote in the New York Times on Oct. 17, 2008, that exaggerated concern about the long-term prosperity of financially secure U.S. companies was foolish, and most would be setting profit records in years to come. A month earlier, New York-based Lehman had filed for the largest bankruptcy in history, deepening a global credit crisis and the worst American recession since the Great Depression.

‘Run the Math’

The $135-a-share price for Lubrizol represented a premium of 24.2 percent over the 20-day trading average. That’s in line with the 24.8 percent average for Berkshire takeovers, according to data compiled by Bloomberg.

“I don’t even need to run the math,” said Philip Orlando, the New York-based chief equity market strategist at Federated Investors Inc., which manages $341.3 billion. “I’m completely confident that he has established the normal parameters of his valuation disciplines.”

The agreement to buy Lubrizol at 7.3 times Ebitda is the cheapest takeover of a specialty chemicals company greater than $500 million since Imerys SA (NK) in Paris paid 5.4 times for English China Clays in 1999, according to data compiled by Bloomberg.

The bid is even lower at 6.7 times estimated 2011 Ebitda of $1.38 billion, according to the average of analysts’ estimates compiled by Bloomberg.

“Berkshire is getting an attractive valuation,” said Laurence Alexander, a New York-based analyst at Jefferies Group Inc. who recommends buying the shares. “The deal suggests Berkshire is more upbeat about the sustainability of margins.”

‘Worry About’

Lubrizol has the largest share in the lubricant additives industry, where more than 90 percent of sales are controlled by four companies, said Michael Sison, a Cleveland-based analyst at KeyBanc Capital Markets. They have been able to raise prices to recoup oil-based raw materials costs and limit capacity additions, he said.

“Pricing power seems to be something that this company does not have to worry about,” Dmitry Silversteyn, an analyst at Longbow Research in Independence, Ohio, said of Lubrizol.

Lubrizol’s operating margin, or the amount of income retained for each dollar of sales, climbed to 20 percent last year from 9.1 percent in 2008.

The company’s lubricant additives business brought in $3.9 billion, or 72 percent of revenue last year, while advanced materials made up 28 percent of sales.

‘American Industry’

“It’s a relatively easy business to understand and one that Buffett can really get his arms around at a decent price,” said Jack Ablin, chief investment officer at Chicago-based Harris Private Bank, which oversees $55 billion and owned Lubrizol shares as of Dec. 31. “Future growth prospects are rather predictable. It’s a Buffett bet on industrial growth, on the growth of American industry.”

The Lubrizol acquisition now leaves Buffett with about $29 billion in cash, data compiled by Bloomberg show.

With Berkshire generating almost $1 billion in free cash flow a month and near zero percent interest rates limiting returns in fixed-income markets, Buffett will probably be eyeing more takeovers, Cambiar’s Barish said.

Excluding Lubrizol, there are still 34 companies with market values from $4 billion to $20 billion that have capital expenses accounting for at least 5 percent of their net fixed assets; a return on equity exceeding 10 percent; profit growth in the past five years that ranked in the top 50 percent; and an average price-earnings ratio in that span that was less than the median in the Standard & Poor’s 500 Index, according to data compiled by Bloomberg.

Buffett’s Criteria

The list includes discount retailer Dollar Tree Inc. (DLTR) of Chesapeake, Virginia; Hormel Foods Corp. (HRL), the Austin, Minnesota- based maker of Spam luncheon meat; and Joy Global Inc. (JOYG), the Milwaukee-based mining-equipment maker that sells drills and shovels.

“It sounds like he does intend to buy more stuff,” said Cambiar’s Barish. “He really does want to get cash to work in good businesses that are durable franchises that will benefit from economic strength. That’s clearly what he’s trying to do.”

Overall, there have been 4,604 deals announced globally this year, totaling $457.7 billion, a 13 percent increase from the $403.6 billion in the same period in 2010, according to data compiled by Bloomberg.

ETFs, the new Mutual Funds

The number of ETFs continues to climb, giving investors more and more ways to approach the stock and bond markets. However, the advantage that gave ETFs their biggest edge was their low management fees, which were often 25 basis points. However, the growing acceptance of these vehicles has led to a creeping increase in fees, which, for many funds are now often 65 to 75 basis points.

I'm reminded of the early promise of Cable TV -- no advertising. Subscribers paid their monthly fee and watched movies and shows uninterrupted by commercials. Hmmm. Where did that go? The same reversion to old practices is underway in ETF-land. The trend of higher fees has ETFs looking more and more like the mutual funds they were designed to beat.

Seven ETF Launches for the New Year

January 26, 2011, 12:59 am EST

Dan Pritch submits: As firms continue to launch new ETFs at a dizzying pace, I thought it would be instructive to take a look at 7 new ETFs launched in January of 2011 across a broad spectrum of asset classes and strategies:

1) – Global X Russell Emerging Markets Value - This ETF will rely upon the benchmark Russell Emerging Market MegaCap Value Index, delving into an already heavily populated space in emerging market hot money flows. While many emerging markets and high beta strategies are focused on growth or momentum stocks, the value focus will add a new tilt to a frothy strategy, perhaps opening the way for some different weighting from the likes of smaller outsourcing firms, manufacturers and financials compared to the large-caps and multinationals from more popular emerging markets ETFs.

2) (NYSEArca: EWAC - News) – Rydex MSCI All Country World Equal Weight ETF – This one takes a stab at multiple attractive strategies, combining a broader world market approach with the equal weight strategy. Many investors like the equal weight strategy since it doesn’t rely so heavily on individual issues that tend to monopolize an entire index. Take the Nasdaq for in stance – Apple (NasdaqGS: AAPL - News) represents an astounding 20% of the Nasdaq ETF (NasdaqGM: QQQQ - News). This ETF would then provide both increased regional, currency and sector diversification while ensuring returns aren’t dominated by large-caps. As evidenced by an existing Equal Weight ETF on the S&P500, we’ve seen prolonged outperformance over its benchmark (NYSEArca: SPY - News). Whether this ETF can deliver similar outperformance remains to be seen, but keep your eye on it.

3) (NYSEArca: WDTI - News) – Managed Futures Strategy Fund – Managed Futures were hot when the market was quite volatile and heading downward. With equities rallying and volatility low, these segments haven’t done so well. But, with the focus on commodities in the news and fears over a weak dollar, it’s no surprise that another managed futures ETF would launch. This particular ETF will seek to track the long/short Diversified Trends Indicator. Another facet to the underlying holdings includes currencies. Since 2004, the DTI has beaten the S&P500 with less volatility, but that isn’t saying much in the face of 2008-2009′s unprecedented market conditions. The Fact Sheet can be found here.

4) (NYSEArca: ALUM - News) – Global X Aluminum ETF – With emerging economies consuming Aluminum in record amounts with their infrastructure build-outs, it’s timely to see the launch of an Aluminum-focused ETF. Of course, this isn’t a direct play on the metal itself, but rather, miners that have a heavy presence in dealing with the material like Alcoa (NYSE: AA - News) and others. As such, expect to see some overlap with other mining ETFs and commodities ETFs.

5) (NYSEArca: SCHH - News) – Schwab U.S. REIT ETF – The ETF universe already abounds with various REIT ETFs, yet we have another now from Schwab. Seemingly, the only benefit over existing popular REIT ETFs will be an extremely low expense ratio of 0.13%. This is a major trend in the industry, using price as a value proposition. Many institutions have gone so far as to actually offer FREE ETF trading in dozens of ETF issues (79 and counting). The selling point for the REIT sector in general is often the high current yield given the pass-through tax structure, as well as a play on a rebounding economy for a sector that was hammered to heavily during the recent downturn.

6) (NYSEArca: AGOL - News) – ETFS Physical Asian Gold Shares Trust – With no shortage of conspiracy theories circulating amongst the gold bug crowd, “physical” gold ETFs have started to sprout up. The intent is to provide investors with an added level of assurance that the gold an ETF purports to represent is actually physically held in trust – in Asia for this particular ETF. The Sprott Gold (closed end) Fund (NYSEArca: PHYS - News), for instance, allows investors to actually redeem their holdings. This has led to some strange premiums that are easily exploited with pairs trades now and then when they deviate too far from the norm. Regardless, I can see little value in this addition to the crowd; whether it’s held in Asia, in Canada, or on paper by legitimate financials, AGOL doesn’t seem to present a compelling investment thesis. There are actually a few precious metals ETFs that tend to beat gold returns in an up market, while of course declining rapidly on the way down.

7) (NYSEArca: VIXY - News) – ProShares VIX Short-Term Future – Often referred to as the fear index, the VIX tends to rally when equities sell off and it drops when stocks perform well, as complacency sets in and volatility drops out as measured by put/call ratios. Previously, investors had the opportunity to play the VIX via various ETNs (exchange traded notes) like (NYSEArca: VXX - News), which subject investors to solvency risk of the parent issuer. So, the selling point here is that these new instruments are structured as ETFs, not ETNs, thus removing that liability.

One could reasonably expect value decay over time due to contango just like what we saw with VXX, USO and other ETFs/ETNs that rely on futures rolls monthly. The only typical entry point for routine retail investors may be for those looking to take a long position in anticipation of, or during, a rapid decline like the recent flash crash or the 2008-2009 financial collapse. Long term, I would expect VIXY to slowly degrade over time as mentioned previously.

Oil Panic of 2008? Who Remembers?

Soon the summer of 2008, when the price of oil hit $147 a barrel, will be forgotten. Just like the two points in the 1990s when oil was selling for $10 a barrel. How about Y2K? When the clocks ticked in the the new year, the year that was supposed to send the world's computers into chaos and confusion, the first day of that year began, as most do, bright and sunny. Just another day on Planet Earth.

We're going to burn oil until there's none left to burn. Meanwhile, over time, energy technology will advance and we will get more and more of our supplies from the sun, the wind, coal and nuclear. There's no mystery about these things. But fear, panic, complacency and arrogance will always cycle through the pricing of oil.

What Happened to $150 a Barrel Oil?

With the reporting of financial markets, there is only one truth: First price, then news. When oil exploded through $100.00 and raced up towards $150.00 in 2008, then and only then, did stories about peak oil erupt all over the web. People took note and some began to prepare for the end of the world as we know it. Solar and wind power farms gained massive and rapid funding. Individuals loaded up storage facilities with canned goods and toilet paper. Panic ensued at the pump. And for a time, automobiles the size of a barbecue grills were seen puttering along the road, careful to avoid being smashed by the army of SUVs.

First price. Then news. Then extreme reactions. Now with oil hovering near $75.00 a barrel, there is nary a trickle about the coming world's demise. In fact, the energy markets are downright quiet and boring these days. And there is plenty of toilet paper in stock at stores all over the world -- no need to hoard the stuff. What gives and how to play this "quiet news?"

Oil prices have been quietly falling lower, much to the chagrin of those who have been longing to say, "I told you so." What's happening? Take a look around and you will note that economic growth is currently a tepid beast without much of an appetite for all things energy. As a result, oil supply is comfortably outpacing demand. Inflation concerns are also on the quiet side. When inflation is a concern, nature's "black gold" will rise as money flees into tangible investments. During inflationary times, cash is trash as inflation reeks havoc on the buying power of fiat currency. But for now, that is not a huge concern and oil prices are trending lower.

There are four main energy related ETFs that I like to use in my own trading. For oil, the best bet is the United States Oil Fund and for natural gas, the United States Natural Gas Fund. These are good for faster markets that are trending nicely. However, when things get slow, as they are now, I like to get a little more bang for my buck. In this case, I will look at the either the PowerShares DB Crude Oil Double Long ETN or the PowerShares DB Crude Oil Dble Short ETN. Since oil prices are currently headed lower and are not showing any signs of strength, I like the double short DTO as a way to participate in any continued downward price movement.

When playing a leveraged ETF, it is important to understand that these instruments can move fast. Traders and investors must use appropriate risk/reward parameters. I typically like to take a position and trail a stop once per week, using the low of the weekly bar. In this case, by purchasing DTO (which rises as the price of oil falls) I can lock in gains each week that oil is moving lower, getting stopped out of my position only when oil has decided to reverse itself. This way, I do not have to know how low oil will go. I can simply participate in its decline for as long as it falls.

If I am able to close out this trade profitably, I can use the money to load up a storage shed full of survival gear. In the event the end of the world does come to pass, at least my neighbor will not have the satisfaction of saying, "See, I told you so."

Junk Bond ETFs and Funds

There's no free lunch. But these days Junk Bond ETFs are giving investors healthy returns and little indigestion.

Reliable income and capital preservation

Successful high-yield investing through bond funds and High-yield bonds, though alternately seen as either sleepy or risky, can serve as part of a core investment strategy, especially during times like ours, when exuberant equity expectations have been subdued and look like they will remain that way for a while.

More investors are looking for reliable income, and capital preservation has become at least as important as -- if not more than -- performance. Higher yields and income become back-to-basics staples among investors during times of austerity, and so the renewed interest in high-yield bonds has not been unexpected.

However, the high-yield market, though not as persistently volatile as stocks, can be suddenly punishing as well as rewarding. High-yield bond prices have generally correlated with the equity markets, as investors link high-yield default risk ahead of interest-rate risk. The inverse has also been true: Generally, when the stock market goes up, so do high-yield bonds as good times diffuse the risk of default. But when investors sense the risk of defaults rising, they will dump the high-yield sector just as fast, as they did in 2008.

No individual bonds

Trading the high-yield market -- and not individual high-yield bonds -- can offset this risk. This means trading high-yield funds and exchange-traded funds to avoid the surprises often associated with individual bonds. It also means developing and sticking to a long-term, time-tested strategy to avoid high-yield bonds altogether when the trend is unfavorable. Enjoying the high-yield payouts -- with traditionally generous dividends -- while avoiding the downtrends, can make for a more profitable combination. Even when missing a trade in one of these high-yield bond funds, the yield itself can more than make up for it.

To successfully trade high-yield funds and ETFs, there are several data points that need to be correlated and monitored. These include price and volume, of course, but also other easily retrievable data, such as closed-end bond premiums or discounts, and high-yield bond new highs and new lows.

These data, when taken together, smooth out extreme indicators in the high-yield market while providing a generally reliable overall indicator that can serve as a trend line; in other words an algorithm. Trading high-yield funds and ETFs does not mean we ignore high-yield spreads against Treasurys or other bond market indicators, but spread-watching is not a primary preoccupation.

Tortoise and hare

Active, though not frequent, trading along the lines of these simple data points with the underlying algorithm has admittedly underperformed equities, sometimes for months on end, but it has outperformed equities significantly in the long run. It's the tortoise and the hare story, and the cycle often repeats just when you think equities are going to run away with the glory.

For the High-Yield ECM Strategy at Garrett Capital, we've used this method since the 1980s, and though we've made slight adjustments over the years, relying on these has ensured that the strategy has not had a losing year. In 2008, for example, this high-yield strategy turned in a positive performance when most indexes -- whether of equities or high-yield bonds -- were down dramatically. And, as many have found, the impact of a large loss on long-term performance is stultifying. Making your money back after big losses takes time.

In recent years more high-yield offerings have become available to investors including ETF's such as the iShares iBoxx $ High-Yield Corporate Bond Fund /quotes/comstock/13*!hyg/quotes/nls/hyg (HYG 88.48, -0.14, -0.16%) , with over $5 billion in assets; the SPDR Barclays Capital High-Yield Bond /quotes/comstock/13*!jnk/quotes/nls/jnk (JNK 39.30, -0.12, -0.30%) , with more than $3 billion in assets; and the PowerShares High-Yield Corporate Bond /quotes/comstock/13*!phb/quotes/nls/phb (PHB 18.09, +0.02, +0.11%) with assets just less than $200 million. These, coupled with many closed-end and open-end high-yield bond funds, provide investors with plenty of choices to enter the high-yield market without having to wonder if an individual bond is worth the investment.

Now is the time to keep an eye on how well high-yield bonds correlate with equity indexes, and on a day-to-day basis. If the high-yield market outperforms, that's usually positive for equities. If the high-yield market responds well when equities drop, think twice about being short: It's likely a signal that equities are ready to rally along with the high-yield market.