XLE - AMZA: An Energy ETF Worth Waiting For

2023-06-06 01:25:30 ET

Summary

• AMZA is an energy ETF with an income focus, investing in midstream energy MLPs and utilizing leverage.
• The ETF has a high dividend yield and stable income, but its expense ratio of 1.64% is steep compared to cheaper peers like MLPA.
• Due to the pending recession, I expect oil prices to go down before they go up, so I rate AMZA a Hold.

InfraCap MLP ETF ( AMZA ) is an energy ETF with an income focus. AMZA provides exposure to midstream energy MLPs ( master limited partnerships ). This ETF is actively managed and uses leverage, options, and short strategies to provide income for investors no matter what state the economy is in. Because of the complexity of this ETF, AMZA has a pretty steep expense ratio of 1.64%. AMZA currently has a very impressive dividend yield of 9% . Although AMZA has some attractive attributes, in the current environment its high expense ratio makes it unlikely to outperform its peers. Therefore, I rate AMZA ETF as a Hold.

Holdings

AMZA holds 25 midstream energy MLPs and about 60 written call and put options. The options currently make up only about 0.2% of AMZA's AUM, so the MLP holdings have much more impact on returns. The way that AMZA holds these MLPs is one of the most unique things about this ETF. As mentioned before, AMZA utilizes leverage in its strategy to produce income. They typically will use about 20-30% leverage and are currently using about 31%. This use of debt is to provide more volatility to its holdings.

As the image shows, industrial services take up about 112% of the AUM and the other 3 sectors, excluding cash and/or derivatives, add about another 19% giving us a little over 131%. This is because of the current use of about 31% leverage. So if we subtract the 31% debt from the 131% holdings, we are left with a typical 100%. Keep this in mind when seeing that the top 10 holdings add up to 116%.

To make this more easily understandable, I have calculated what percent of the AUM the top 10 holdings take up excluding the 31% debt. The top 10 holdings take up about 89% of AMZA's AUM excluding debt used as leverage. That means that this ETF is heavily skewed to these top 10 holdings, only leaving 11% (again, excluding debt) for the remaining 15 companies.

This isn't just a typical energy ETF that focuses on income. In fact, AMZA has only a 3% overlap with XLE , the energy sector benchmark, showing just how different the holdings of AMZA are.

MLPs and income

AMZA investing in MLPs is one of the reasons this ETF can produce stable income. MLPs are typically long-term investments that provide slow, but very stable income. MLPs are lower risk than most energy companies because they are involved in slow-growing industries, in this case, the midstream energy industry. Keep in mind that midstream MLPs are correlated with oil, they just fluctuate less due to their lower beta. MLPs get most of their cash flow from long-term contracts, leading to a consistent source of income. AMZA uses leverage to give these MLPs a higher beta in hopes to make more profit from the slow growth of these companies.

Dividends

In the last two and a half years, AMZA has provided a stable dividend yield, with the yield ranging from about 7.5% to 10.5% (currently showing a yield of 8.4, compared to the 9% mentioned before due to YCharts and InfraCap using different dividend calculation methods). This yield is extremely high compared to most energy ETFs.

AMZA's dividend yield is over 4% higher than VDE and XLE, both energy sector ETFs, and about a percent higher than the global MLP ETF, MLPA. Because the midstream companies AMZA holds have a consistent and stable stream of income, AMZA should be expected to continue having high yields.

Expense ratio

Up until I saw the expense ratio, I liked this ETF a lot. AMZA has an expense ratio of 1.64%. This is an actively managed ETF and it does a lot of complicated things such as writing option contracts and using leverage, so this expense ratio isn't absurd. However, these extra services haven't proved to do enough to justify not just buying a cheaper peer. For example, MLPA has an 85% overlap with AMZA and an expense ratio of 0.45% .

MLPA doesn't provide any leveraged MLP or option exposure, but it has produced similar returns in the past year.

AMZA vs MLPA

In the past year, AMZA and MLPA have performed similarly, and they will likely continue to do so because of their heavy overlap. The only time AMZA has been shown to outperform MLPA is during high upswings in oil. This is due to AMZA's leveraged positions. Both MLPA’s holdings and AMZA’s holdings will be affected the same by the oil spike, but AMZA takes on more risk due to the leverage and therefore will get more reward.

The chart above shows AMZA's 6-month total returns performance relative to MLPA for the last 5 years. Historically, AMZA has underperformed, or performed the same as MLPA, with the big outlier being when AMZA outperformed by nearly 40%. This can be explained by the huge spike in oil happening after the Covid recession. Oil went from about negative $37 a barrel then back to about $60 per barrel in about half a year. Midstream companies are less correlated with oil than upstream and downstream companies, but they still move with oil. Because of the leveraged position, it outperformed MLPA by a lot. With just one instance of truly superior returns, and the rest of the time having similar or worse returns than MLPA, I don't see a reason to pay over a percentage point more in expenses for AMZA except in a few rare situations.

When AMZA becomes a Buy

The only time AMZA would become a Buy is after a big drop in the price of oil. When oil inevitably recovers from a large drop and begins to go up in price again, AMZA would outperform other midstream MLP ETFs because of its leveraged positions, while still providing an impressive dividend yield.

AMZA should definitely be on your watch list. The right time to buy may be coming upon us. If the economy goes into a recession and oil drops at least 10% due to lower consumption, this would be the perfect time to buy AMZA. As the economy comes out of the recession and consumption begins to pick up again, AMZA will outperform because of its use of leverage, and if we remain in the recession for longer than expected, the high yield will make it easier to wait out the storm.

Why now isn't AMZA’s time

AMZA is an attractive ETF with its high yield and lower volatility relative to most energy ETFs, but it's still only a Hold for me. I like this ETF because it brings investors an opportunity to own something that is high yielding, but also adds a growth aspect to a slow-growing industry using leverage. However, I think that very soon it could be bought at a cheaper price.

Inflation isn't low enough for the Feds to stop raising interest rates. Although it's looking like the Feds will skip a hike in June , they will almost certainly return to raising them further in 2023. The longer we aren't in a recession , the worse the coming recession will be.

What the Fed has done so far hasn't been enough to sufficiently slow the economy. Inflation and payroll data are still coming in higher than expected. This means the Fed is going to have to get even more aggressive, causing consumption to go down, and therefore the price of oil.

Conclusion

AMZA is a unique ETF that would be very attractive in an environment where oil prices are going to rise. However, I think oil prices will fall significantly before they rise again. Macroeconomic factors still cause me to believe we are headed to a recession and that it will lead to cheaper oil. I think that the lower volatility of AMZA compared to most other energy ETFs, as well as the stable stream of income, make it a great long-term investment, but I think it would be wise to wait until we enter a recession to get AMZA at a better price. Because of this, I rate AMZA a Hold.

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