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Red flag at popular ETN

JPMorgan stopped issuing shares in its Alerian MLP exchange-traded note; investors could get whipsawed if price spikes

Jun 20, 2012 @ 12:22 pm

By Jason Kephart

JPMorgan
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Other flags ((Photo: Bloomberg News))

Advisers invested in the $4.27 billion JPMorgan Alerian MLP Index ETN Ticker:(AMJ) need to start watching the fund much more closely.

JPMorgan Chase & Co. stopped issuing new shares of the exchange-traded note Wednesday as the fund reached 129 million shares, the maximum number of shares allowed, according to a note on the company's ETN home page.

By no longer issuing new shares, the ETN essentially has morphed into a closed-end fund. That means it no longer is likely to trade at net asset value. If a sell-off takes place in the master-limited-partnership sector, the ETN's share will probably trade at a discount.

But given the demand for MLPs or, more specifically, their relatively hefty dividends, it's more likely a premium could develop — a possibility that JPMorgan warns about on its website.

Indeed, investors this year saw how dangerous a ETN that trades at a high premium can be. The Credit Suisse VelocityShares Daily 2X VIX Short-Term ETN Ticker:(TVIX) stopped issuing new shares in February. The shares quickly doubled in value. But when Credit Suisse Group AG resumed issuing shares in March, the ETN's share price promptly collapsed back to the NAV, wiping out $172 million in a single day.

Following that tumble, the Financial Industry Regulatory Authority Inc., the Securities and Exchange Commission and Massachusetts' securities regulator all took note and announced that they would begin looking into how ETNs are sold to consumers.

MLP fans do have other options, although they come with their own set of risks. The $3.7 billion ALPS Alerian MLP ETF Ticker:(AMLP), for example, offers an entry path into the MLP space but does so with extra tax consequences.

The ETF is structured as a C corporation to avoid having to pass on pesky K-1s to its shareholders, but that opens it up to corporate-level taxes, which cause the ETF to have trouble tracking its index.

In 2011, the ALPS MLP ETF had a tracking error of nearly 7%, the highest of any ETF, according to a Morgan Stanley Smith Barney LLC report.

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