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These are the worst of times for fixed income investors. With rates on five year CDs hovering around three percent and treasuries yielding even less, many fixed income investors have seen their income sliced by half. And you might as well shove your money under a mattress before sticking it in a money market account. To add insult to injury, some banks have the gall to give you zero percent interest on your checking and savings. Bonds are little better with AA or better bonds yielding somewhere in the 3 percent range.
And then one has to consider the risk factor. At the current anemic rates, putting any money in bonds or government securities exposes you to major and potentially catastrophic capital losses when rates go up.
Hoping to make your money on dividends? Well, even there, there is no safe haven in many of the companies that have been the bedrock for fixed income investors. The recession has forced many of them to slash their dividends.
So what's a battered fixed income investor to do? Well one option that is becoming more popular is buying into Master Limited Partnerships, which have steady cash flows and pay dividends that are currently running at seven percent or better.
Master Limited Partnerships (MLPs) are unique investment vehicles. One of their most attractive features is that, unlike most companies, they pay no corporate taxes. Income flows directly to shareholders which are called 'unit holders.' The unique tax provision that allow for this type of corporate entity is restricted to companies that manage assets with a predictable and steady flow of revenue - like oil pipelines. In fact, the raison d'etre for an MLP is to generate and distribute a steady cash flow to unit holders. In many ways, MLPs are more like bonds than stocks, except that they offer a unique advantage over bonds because of their ability to grow the business with new acquisitions - like adding new pipelines to their network. What makes them less volatile than stocks is their fat dividends which currently exceed 7%.
What Are MLPs?
The ability of an MLP to deliver steady and predictable cash flows is tied to the nature of their business. The most common type of MLPs are energy related transport companies. A good example is a company that owns and operates oil or gas pipelines. Think of MLPs as utilities that provide services to energy producers or as toll roads for energy. Every day, energy is moved all over the country to make the journey from production facilities to our homes, cars, and work places. Pennsylvania coal needs to be hauled to Wisconsin for winter heating. Oil from Oklahoma needs to be piped to Chicago. Moving energy from point A to point B is a monotonous job but somebody has to do it. Good times or bad, regardless of energy prices, the aggregate amount of energy we consume as a nation is fairly stable. Just as the number of cars has changed little during this recession, there is little variance in the amount of energy we consume and that fact is reflected in MLP revenues.
MLPs consist of a general partner that typically owns 2% and limited partners that own the balance. The general partner manages the operation and ensures that cash flow is distributed to all unit holders. Both limited and general partners receive quarterly dividends and can benefit from any appreciation in the value of the underlying assets. If the going rate for a mile of pipeline goes up, so does the value of the MLP. Since there is little change in revenues for existing assets, most revenue growth comes from acquiring new pipelines or other assets. MLPs increasingly have gone public so that their units can be bought and sold just like any other stock.
Structurally, they're very similar to a real estate investment trust (REIT). Except that instead of managing apartment compounds - they operate pipelines. And instead of collecting rents - they charge oil and gas producers fixed rates for transporting their products to consumers. And just like a REIT can expand its real estate holdings, an MLP can buy more pipelines.