Oil Bull Market Is No Place For MLP ETF Investors

Thanks to an improved economic outlook, promise in the Greek debt deal, and tensions with Iran, energy commodity prices have been on the rise in 2012. WTI crude has added about $10/bbl. so far this year while gains from the past six months are equally impressive, coming in at about $20/bbl. Many analysts expect that this is just beginning for the vital commodity as economic trends continue to be favorable while the Iranian crisis doesn't appear to be ending anytime soon either.

As a result of this reversal in outlook for the oil sector, strong gains have also been in the equity side of the oil market as well. Oil service ETFs as well as those in the exploration sector have seen double digit gains so far in 2012, led by PXE's 16.6% gain and IEO's 12.7% surge. Meanwhile, the jump in oil has also helped the beaten down clean energy sector too, as the Progressive Energy ETF (PUW) added about 17.2% in year-to-date terms, while the most popular Solar ETF (TAN) added 13.3% in the same time period (read Time To Consider The Small Cap Oil ETF).

However, this strength has not filtered over into the MLP ETP space as well. These securities have lagged behind their peers by a wide margin in 2012, although they have still managed to squeak by in the positives so far. In fact, of the ten worst performing energy ETFs so far this year—including alternative energy, coal, etc.—MLP products occupy half of the spots. Only the UBS E-TRACS Wells Fargo MLP ETN (MLPW) managed to place outside of the bottom ten, coming in 20th overall.

This significant underperformance may be a surprise to many investors given the increased popularity of the product in recent years. Two MLP funds—AMJ and AMLP—both have more than $2.5 billion in AUM while another two have amassed more than $200 million. Additionally, the sector has been a top performer from a one year perspective, as MLP funds take up all six of the top spots from a 52 week return view (Read Is An Oil Sands ETF On The Horizon?).

Beyond this solid performance from the one year level, MLPs have become very popular among investors due to their higher levels of income which can often crush dividend payouts of comparable equities. This is because MLPs are generally pipelines or other key infrastructure assets which pay out solid rates back to investors on a regular basis.

Unfortunately, however, this strategy means that when oil prices are surging they do not benefit as much as some of their peers. This is because the oil tends to flow through the pipelines no matter the price of the commodity, a situation that promotes safety but can hurt total returns in bull market environments (read Three ETFs For An Iranian Crisis).

This has especially been the case so far in 2012 as oil futures ETFs have seen solid performances in the first two months of the year. This has pushed exploration and service focused stocks and ETFs into a leadership role, leaving MLP funds and notes by the wayside. So while MLP ETNs and ETFs may be extremely popular among many investors, surging oil prices aren't exactly their best friend (read Closer Look The Canadian Energy Income ETF).

MLPs tend to perform similarly no matter what the price of oil is and can be better performers in times of weak prices. Thanks to this, which is evidenced by recent performance in both the MLP and equity markets, investors who are expecting a further run in oil could be better served by exploration and service firms while those expecting a bear market in crude, but still want to remain in the space, could be better off looking at MLP products instead.

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Eric Dutram, Zacks Investment Research