ETF Expert Corner

Amplify ETFs CEO Christian Magoon Spotlights Oil Hedged MLP ETF, Online Retail ETF

August 22nd, 2017 by ETF Store Staff

Christian Magoon, CEO of Amplify ETFs, spotlights the Amplify YieldShares Oil-Hedged MLP Income ETF (AMLX) and the Amplify Online Retail ETF (IBUY).



Transcript

You can listen to our interview with Christian Magoon by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: The ETF we're spotlighting this week is the Amplify YieldShares Oil-Hedged MLP Income ETF, ticker symbol AMLX. This recently launched back in June and joining us via phone from just outside Chicago to discuss this ETF is the CEO of Amplify ETFs, Christian Magoon. Christian is a highly respected ETF industry veteran. He's been involved in the launch of over 60 ETFs. He was actually President of the old Claymore ETFs, which ended up getting bought out by Guggenheim back in 2009. I'm not sure there are many people walking the face of the earth that understand the nuts and bolts of ETFs as well as Christian - just a tremendous ETF resource. Christian, as always, a pleasure having you on the program today.

Christian Magoon: Thanks for having me. It's great to be back and congratulations on the continuing success of your program.

Nate Geraci: Well, thank you, Christian. Let's start with a few of the basics for listeners who may be unfamiliar with the energy MLP space. High level, can you explain for us - what are master limited partnerships, how do you invest in them, and why has this space historically generated a fairly substantial amount of income for investors?

Christian Magoon: Energy Master Limited Partnerships are really the infrastructure that transports oil and gas around North America. It's a structure that was created around the time of Ronald Reagan to incentivize individuals and companies to invest in the infrastructure supporting energy discovery, transportation, refining here in the United States, for the US to become more energy independent. And part of the uniqueness of that structure, similar to real estate investment trusts, is that MLPs have to pay out majority of their earnings and revenue each year in order to have favorable tax treatment. So they tend to have very high distributions in order to essentially pay out income to investors and maintain their status as a master limited partnership. So many investors find out about MLPs, energy MLPs, because they're looking for income, and they're looking for income from something other than bonds or real estate, and they find this corner of the market that has healthy distributions - somewhere six to seven percent generally in current market environments - and it has a unique correlation, or a unique relationship to stocks and bonds - tends to have a lower correlation, or actually zig when some of the other asset classes zag. So it's another tool, if you will, in the toolbox for income investors.

Nate Geraci: Alright, so back in June, you launched the Amplify YieldShares Oil-Hedged MLP Income ETF, again, ticker symbol AMLX. Walk us through how the MLPs in this ETF are selected, and explain the purpose of the oil hedge and how that works.

Christian Magoon: Right, so in this ETF, the ETF really has two sleeves it owns. The first sleeve is it owns MLPs. 20 master limited partnerships that are based in North America, focus on oil and gas production, have a market capitalization of more than a billion dollars, and have a significant amount of daily trading volume. And the portfolio is comprised of 20 MLPs that qualify, and they're equal weighted, and tracks a strategy that re-balances these 20 companies on a quarterly basis. So that is kind of the MLP exposure, if you will. The unique part about this MLP ETF is that it seeks to hedge against one of the larger risks that impact MLPs, and that is the price of oil. The price of oil can actually have a positive or a negative impact on MLPs. And currently, the majority of MLP funds that are in the marketplace really have a high correlation, or behave very similarly to what actually oil prices do. So we look at some of the larger ETFs, like the Alerian MLP ETF, or the JP Morgan Alerian MLP Index ETN, and their three year correlation to crude oil is .89 and .92, respectively. And the idea with this fund is actually to have a short position against oil to profit when oil falls in order to make the fund less sensitive to oil price declines. MLPs are a great income source, but they've had several years in the last 10 years where they've had 30% drawdowns, and those drawdowns have happened when crude oil prices have essentially declined significantly. So the ETF is designed to try to mitigate that risk, similar to what currency hedged ETFs try to do when they're trying to hedge against risks of investing in companies like in Japan, where the currency can sometimes eat away a lot of the returns when the funds’ returns are translated to US dollars.

Nate Geraci: Christian, as it relates to this negative relationship with the price of oil and MLPs, can you help us better understand the business model of MLPs? I guess a question I would have is are they not locking in rates for transportation and storage ahead of time? Why is it that MLPs do tend to fall in price if the price of oil falls?

Christian Magoon: That's right. MLPs do usually have three to five year contracts so that they become toll takers for the oil and gas, for example, going through their pipelines. For every one you see large movements in the price of oil - we've seen oil go from a hundred dollars to thirty dollars, thirty dollars to fifty dollars, and who knows where it's going next - when you see those types of movements, even though the MLP may have longer term contracts, we're seeing the price of the MLPs, the share prices, start to move. Now, for some people this could create some opportunities, because perhaps the move in oil doesn't happen as significantly as what the market thinks it's going to do, and maybe you're able to buy MLPs at a discount. But it's hard to ignore that in 2015 and in 2008, MLPs declined over 30%, and those were both years where crude oil actually had large declines. The other thing to note is the three year correlation of kind of the average MLP product out there is about .8 or greater, .89 or .92 for the two largest to oil. So many people are unfortunately, they're trying to buy MLPs for income. They don't realize that they're really making a bet on oil prices. And as we know with the disruptive technology and the volatility of oil, we think there's a better way to potentially mitigate that risk, or at least dampen that volatility of MLP investing when it comes to oil prices.

Nate Geraci: What about the cost of the oil hedge? I'm curious, what sort of impact can those costs have on the performance of the ETF if oil prices don't decline - both in terms of actual transaction costs, but also contango?

Christian Magoon: That's correct. So there is a cost to hedging. There's definitely no such thing as a free lunch, and the cost can exceed more than one percent a year in markets where you're not seeing oil prices decline, but you're seeing oil prices rise. The actual performance lag can be fairly substantial as well if you're hedging against oil prices and they're not declining, instead they're going from 50 to 100. But over time, at least over the last 10 years, you've seen a very positive return by implementing an oil hedged product. Not only better upside, so in years like 2008 where the Alerian MLP Index was down over 38%, the Oil Hedged MLP Index was actually positive that year, 1.9%. Also, years where the Alerian MLP Infrastructure Index did quite well, up 85% in 2009, the oil hedged product participated in that market and was up actually more than that at 98% in 2009. Of course that was after the financial crisis. So there are costs involved. The goal of this product is to hopefully produce income that's the same or higher. The yield of the index is actually slightly higher than the Alerian MLP Index, which is kind of the S&P 500 of MLPs. And hopefully over the course of a market cycle, you're able to see less volatility in owning MLPs and we're hoping for some outperformance - certainly better risk-adjusted performance, which we think is important for income investors who tend not to like very volatile NAVs on their income producing assets. And again, the Hedged MLP ETF is designed to try to dampen that volatility around oil prices.

Nate Geraci: Lastly, before we move on, because I do want to ask you about your Online Retail ETF as well, what about taxes? And I don't want to get too far into the weeds, but the tax nuances of MLP ETFs can certainly get a bit confusing for investors. How is this ETF taxed?

Christian Magoon: Yeah, so this is structured as a C-Corp, similar to I think most other MLP ETFs that have the majority of their portfolio in actual MLPs. So if you're an individual investor, and you own an MLP now, not an ETF, but just an MLP, you're going to get a K-1. One of the advantages of an MLP ETF is not only do you buy a basket of MLPs, but our ETF and many others actually take care of the K-1s at the fund level, and so that you only get a 1099 as an investor. So that's a convenient option, and one your tax professional will probably pat you on the back for come April 15th.

Nate Geraci: Our guest today is Christian Magoon, CEO of Amplify ETFs. Christian, let's switch gears and touch on the Amplify Online Retail ETF, ticker symbol IBUY. This has been one of the better performing ETFs year-to-date. It's up nearly 30%. And this ETF owns a global basket of about 40 companies generating 70% or more of their revenue from online sales. This includes all the players one might expect - Amazon, Netflix, Wayfair, Priceline, Shutterfly. What's been driving performance this year?

Christian Magoon: Yeah, well it's really been interesting. So online retailers have just trounced the brick and mortar retailers. Just looking at performance numbers, just year-to-date, the IBUY Amplify Online Retail ETF is up 27%. That compares to the SPDR S&P Retail ETF, which is primarily brick and mortar, down 13%. So 40 percentage point difference. What's driving it are just some of the online retailers globally that are doing quite well. An example would be company like Alibaba that has gained over 80% year-to-date, just reporting earnings last week, had a 56% growth year-over-year on revenue. Very strong numbers. And Alibaba, up 80%, is only the sixth best performing online retail stock of the year. Many people think of Amazon when they think of the Online Retail ETF. That is a company we hold. It is generally not one our top 10 holdings because we have an equal weighted portfolio. But Amazon, for example, is only the 19th best performing online retailer in the ETF this year. Some of the leaders are Wayfair, PetMeds believe it or not. They receive 70% or more of their revenue from online retail sales. PayPal has been another strong performer. So many of these companies that are here in the US, and even around the world - Alibaba and JD.com are in this online retail ETF - we think it's the future. Only eight and a half percent of all retail sales currently are in the online space. So we think it's still in the early days and there's a lot more opportunity for these companies to grow.

Nate Geraci: Well, on that note, when you talk about still being in the early days, if you look at some of the traditional retailers, like Walmart, obviously they're spending a lot of resources trying to develop an online strategy. And actually, in the case of Walmart, they purchased Jet.com. How do you expect Walmart and other traditional retailers to continue to evolve and how might that ultimately impact the Alibabas and Amazons of the world?

Christian Magoon: Yeah, that's great question. Traditional brick and mortar retailers are reeling. They're seeing store sales for the most part are declining, quarter-over-quarter, year-over-year. And they're having to make significant investment in their online business model. The problem is many of these traditional brick and mortar retailers have fairly large real estate costs, fairly inefficient operational systems. They don't use a lot of automation and robotics, for example. And they have rising employee costs. Their other big obstacle is they have a hard time attracting the talent, the tech-oriented talent, into a Macy's for example, or a Kohls, to really transform their business. So we're seeing companies like Walmart kind of give up on their organic online retail business and go out and buy Jet.com, a group of former Amazon employees who had the success in their platform so they could bring it in and hopefully inject Walmart with more online retail know-how. So this is going to be a year where we're going to see continued brick and mortar bankruptcies. We're now almost to the point of the same rate of bankruptcy filings by brick and mortar retailers as we were in the financial crisis, where we've seen over 85 hundred store closings announced this year of physical stores, more layoffs. It's a sea change that's happening. Online is winning. This is another area that technology is disrupting. And we're going to see, I think, a lot of mergers and acquisitions, and some consolidation of brands. But you're right, overall, brick and mortar has to start spending more on online retail operations, and they may have to just go out and acquire it, because they don't seem very adept at growing it organically.

Nate Geraci: What about the other way around? We've seen some online retailers actually opening up brick and mortar stores. For example, Amazon opening a flagship store in New York City, or I guess we could even look at their pending Whole Foods acquisition as bringing a brick and mortar presence. How do you see that model evolving?

Christian Magoon: Yeah, so we think what we're moving towards is what we call an omni-channel retail experience. So online retailers are now starting to value some physical locations, but they view these physical locations differently, not just as a showroom, which is what traditionally brick and mortar use it for, but instead as a place where you can pick up packages, maybe in a locker system, where you could have deliveries going out the back door, hopefully through autonomous cars. You could potentially have drone delivery, or just in time delivery. Amazon is pioneering a 10 minute to one hour delivery in some cities, I think six cities currently. An experience where you may not even have cashiers, where you're paying for items via your smart phone through a scanner. So we think the traditional brick and mortar kind of physical experience is going to be totally reinvented from the online retailers. And that will, I think, be a great opportunity, because when you go into physical stores, there's the potential for last minute purchases, and should be a good way for online retailers to connect a little bit more fully with the consumer, face to face. Keep in mind, only eight and a half percent still of our sales in the US are done through online, so the majority aren't. And there's a ripe opportunity there. That's where companies like Amazon and others really stand to gain significant market share. We think online retail sales could be 20 to 30% of all US retail sales in the next three to five years, and that will do wonders for the stock prices of the average online retail firm, which we define as a company that has 70% or more of their revenue coming from online sales.

Nate Geraci: We're visiting today with Christian Magoon, CEO of Amplify ETFs. Christian, you began alluding to this a bit earlier, but can you talk a little bit more about the back end of these online retail businesses? We're all certainly familiar with the front end - the slick websites, the apps, the fast deliveries. But I'm curious as to how you view the innovation behind the scenes, just in terms of warehouses with robotics or the use of artificial intelligence? What's happening behind the scenes?

Christian Magoon: Well, efficiency is probably the big word, I would say, Nate, that's happening. It's the use of automation that's generations ahead of many brick and mortar stores. The amount of human employees are less, but they’re paid higher rates and they're much more efficient in terms of their time, their productivity is off the charts. When you look at some of the research on the human element in terms of how much a human touches, for example, an order at Amazon versus some of the brick and mortar stores, it's just automation, robotics taking over in that back end. Things are more efficient. And that leads to new applications that we'll likely see soon, which will end up taking warehouse automation and robotics and connecting it with potentially autonomous vehicles, drones, et cetera. And this just gives these traditional retailers fits because they're still trying to figure out how to make a better shopping cart experience on their clunky website. And here, we've got the Amazons of the world, the Alibabas of the world, even PetMeds of the world really using next generation technology to become a more efficient business. And that know-how will eventually be translated into the brick and mortar world. The question is will the brick and mortars be belly up and the online retailers will be buying them for pennies on the dollar? Or will the traditional brick and mortars consolidate, gain some balance sheet, and then try to make some acquisitions in the online retail space at premiums to try to, again, bring that technology and that advantage into their business? So we see online retail winning both ways, either picking up the scraps of traditional brick and mortar, or potentially being M&A targets from the survivors of brick and mortar. And we think that bodes well for investors who are focused in this area.

The sad part from the investing public is you look at for example ETF assets, there's much more ETF assets, maybe 10 times more ETF assets in brick and mortar retail ETFs than there is in online. So we really hope that investors start to look at online retail as a way to compliment or maybe hedge against kind of this big technology, this disruption, because it seems like each week we're seeing another store announce bankruptcy filing, or reorganization plans, and it's really not looking pretty in that area. This is technology disrupting, and that's why we launched the Amplify Online Retail ETF, and why we call it IBUY. I buy electronics, I buy shoes, I buy diapers, I buy office supplies. That's kind of where it's at now is I buy online retail. And again, we think it's still in the early stages.

Nate Geraci: Christian, lastly here, I don't think our conversation would be complete without a reference to a President Trump tweet. Last week, President Trump tweeted out, "Amazon is doing great damage to tax paying retailers. Towns, cities, and states throughout the US are being hurt. Many jobs are being lost!" And he's been critical of Amazon before. Is this a real issue for Amazon and other online retailers?

Christian Magoon: It's a real issue for Amazon, but I think President Trump has it backwards. Amazon is one of the only online retailers that actually collects sales tax on transactions done directly with it in all the states that charge sales tax. So there's 45 states in the US that charge sales tax. So Amazon's actually at a disadvantage compared to other online retailers who don't collect sales tax across all the states. Amazon just started, they added the last five states April 1st, so they haven't been doing it forever, but they are fully compliant, actually are a little bit priced at a premium level because they do that. So if President Trump or Secretary Mnuchin and the Treasury Department want to focus more on the collection of online retail sales tax, it actually benefits a company like Amazon because it will level the playing field. This is kind of a unique tweet by Trump. I think some of the destruction of jobs in communities for retail happened 15 years ago with Walmart. It didn't happen with Amazon. Many people are saving money with Amazon, and Amazon is in the midst of hiring 100 thousand new employees, and not at Walmart wage rates, but quite a bit higher, and teaching them many technological skills to make them very efficient. So I think that was a politically motivated tweet. I also think it's a risk for Amazon stock that you could see some more Trump tweets, or maybe FTC actions against it because it is getting so big. Could there be some antitrust actions? And that's one of the reasons we think you want to own Amazon in a basket of securities instead of having that single stock risk.

Nate Geraci: Well, Christian, with that, we'll have to leave it there. Congratulations on all the success with IBUY, and we certainly wish you similar success with the Oil Hedged MLP ETF. Thank you for joining us today.

Christian Magoon: Thanks, Nate. Appreciate it, and congratulations on The ETF Store Show. Great show, and awesome podcast as well.

Nate Geraci: Thank you. That was Christian Magoon, CEO of Amplify ETFs. And you can learn all about the Amplify ETF lineup by visiting AmplifyETFs.com.