Investing In MLP’s (Investing 101 Series 1)
By Eliseo "Jojo" Prisno, CRPC, MS
Chartered Retirement Planning Counselor
Since we started recovering from the most recent global market downturn from 2008, the FED’s policy has been focusing on cheap money. A basic theory in finance states that a low interest rate will move money quickly. Or in simple terms, if borrowing money is cheap businesses it can easily capitalize their operations, which in turn expands revenue, increases employment, pays more taxes and ultimately rejuvenates the base economy. This type of environment likewise influences the securities investment universe. Because of cheap money, investors tend to margin their accounts which creates more demand for the security they are investing in (a margin account is hedging your first dollar for another dollar borrowed at a fixed rate…I’ll talk about this in my next Investing 101 series… thus pushing stock prices up. Remember the stock market is a function of supply and demand. If there are more buyers than sellers, the investment tends to go up. Access to cheap money creates more buyers and pushes demand. The company that receives the investments (the stocks you invest it) gets access to capital which will eventually help their capital demands. A well capitalized company normally has a better chance for success in their operations and in turn delivers better return to investors. In this perspective, cheap money creates a win-win scenario.
On the other side of the securities universe, the bond market creates the same effect: a low interest rate tends to push bond prices up (old bonds issued at higher interest when sold for liquidity normally are sold at a premium or higher than the redemption value). However, the effect on the yield is the opposite; yield tends to be lower (yield is computed as interest rate divided by bond price); thus growth on bond investments stagnates. This scenario creates a perspective that bond investment becomes inefficient (though this inefficiency is a mere function of liquidity).
What is the best compromise in creating a really solid security investment portfolio in this type of environment? Asset allocation is of course key, if you tend to be with the classic asset allocation standards of balanced programming (i.e. 80:20 stock/bond mix if you are less than 40 years old, 60:40 if you are between 40 to 60 years old and 20:80 if you are retired) try to deviate from the norm. Adjust your risk tolerance a little bit and take advantage of the investment headwinds. Rather than doubling up on bonds or insurance products and annuities, explore other asset types which deliver solid cash flow like blue chip high dividend stocks (the likes of Chevron which pays 4% dividend, AT&T pays 5.7%, Verizon pays 4.5%, Philip Morris at 5.1% just to name a few) . Another asset class which I want to introduce in this Investing 101 series that can deliver high dividend income are MLP’s or Masters Limited Partnerships.
What are MLP’s?
Wikipedia defines an MLP as follows: “A master limited partnership (MLP) is a limited partnership (company organizational structure) that is publicly traded on an exchange or the stock market. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities.”
MLPs are limited by United States federal law to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction and transportation. To qualify for MLP status, a partnership must generate at least 90 percent of its income from what the Internal Revenue Service (IRS) deems "qualifying" sources. For many MLPs, these include all manner of activities related to the production, processing and transportation of oil, natural gas and coal. Some real estate enterprises qualify for a similar tax treatment as a Real Estate Investment Trust (REIT) which I will articulate in my next Investing 101 series articles. Other publicly traded partnerships, for example, the Blackstone Group or Cedar Fair, do not qualify for pass-thru tax status and must pay federal corporate income taxes.
Note: This article will be the first of two series so pardon me if will take you two months to completely learn the topic. A one page allocation for this article is not enough thus please look forward to next month’s issue.
To learn more of the topic, I recommend you visit Investopedia.com on the web. If you want to invest on MLP’s, contact investment professionals who are licensed in securities.
About the writer: Eliseo Jojo Prisno is a Chartered Retirement Planning Counselor and for over a decade has managed the wealth of select families and business owners. He founded P/E Capital Investments in 2010, a State Registered Investment Advisory Firm (CRD# 172695) and is the current Managing Director and Senior Investment Advisor of the firm. Mr. Prisno also manages a Fund of Funds Portfolio with Ameritas and runs an All Equity Growth and Income Portfolio in Separate Accounts via E-Trade Financial. If you have questions or desire a complimentary analysis of your retirement readiness, call toll free to 1-888-929-2825 or visit our page on facebook or our website: www.PEcapitalinvestments.com