Bonds have long been the backbone of the safer, or more conservative, portion of an investment portfolio, and many bond-owning mutual funds have been stellar performers this year. But now bonds are looking riskier. As of November 19, 2009, the yield on ten-year Treasury bonds is 3.3%. The 30-year is not much better, just under 4.2%. The only way investing in those bonds makes sense is if you are convinced inflation will remain low for an extended period of time. Interest rates are so low that they’re more likely to go up than down, and that could undermine bond prices. Not to mention a serious rise in consumer prices which could mean those invested in bonds could lose money. *
Inflation-protected government bonds (TIPS) are expensive too. The five-year offers a real yield of just 0.8%, and even twenty-year TIPS, which are usually a better deal, are only paying out 2% over inflation. *
It's easy to see how this happened. After the trauma of last fall, everyone's been pouring their money into bonds. If you want to sell a bond before the term is up, its price will be determined by supply and demand in the market, and that’s largely governed by changes in prevailing interest rates. Rising rates drive bond values down, falling ones push them up.
Keep in mind that a hold-to-maturity strategy does not eliminate all risk. If rates rise substantially, you can be stuck with an unpleasant choice between sticking with your stingy older bond until it matures, or selling it at a loss to invest in a new bond that’s more generous. Interest rates are currently at an all time low with only one place to go from here…up.
So with short, intermediate, and long-term bonds currently suffering from interest rate, inflation, and market risk, where can investors turn to find the yield they are accustomed to seeing in their portfolio?
We believe Master Limited Partnerships (MLP’s), which are publically traded partnerships on the NYSE and generally involved in the energy sector, are a superior option for income investors. As with any stock listed on a major exchange, information on price trends, charts, bid/ask spread and other data needed for sound investing decisions is far more available than with bonds.
MLP’s can offer investors an attractive expected total return via a high tax advantaged yield plus growth in distributions which have exceeded inflation in every year since 1998. Even during the low yield environment we are currently experiencing, many MLP’s offer a tax advantaged yield between 6%-11%. MLP’s offer separate risks than those found in fixed income securities such as Treasury bonds and FDIC-insured CD’s. Generally MLP assets should be long-lived, generate predictable and stable cash flows and have minimal commodity price risk, but distributions are not guaranteed, and some smaller MLP’s are thinly traded. Each of the energy MLP sub-sectors has its own dynamics, with some more exposed to energy prices, spot rates, and weather risks than others.
In conclusion, MLP’s combine qualities of both bonds and stocks, such as tax advantaged high yield, stepped up cost basis, and daily liquidity. We believe given the current interest rate environment that MLP’s may be a more appropriate risk adjusted investment than other means of income such as bonds and CD’s. Not all MLP’s are created equal, and investors should consult with their investment and tax advisers to determine whether MLP’s are suitable for their circumstances. We consider ourselves experts with regards to MLP’s as we have close to 10 years experience managing the assets in clients’ accounts.
*Financial Quotes provided by Bloomberg
Past performance is no guarantee of future results. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities, markets or issues mentioned. The information contained herein, while not guaranteed as to accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice. Due to the legal structure, tax implications, and tax filings, Master Limited Partnerships (MLP’s), may not be appropriate for certain types of accounts.
