Predictable Income in 2014?

In last week’s article, we mentioned that one of our recommendations we feel most strongly about if a client is seeking predictable income in 2014 is to stay out of bonds.  As Warren Buffett recently said, “Bonds are now priced to deliver return-free risk.”  Let that sink in.  None of the people we talk to are very eager to start taking return-free risks.  So given the fact that bonds have historically been the primary tool of choice for income investors, our recommendation to avoid them usually leads to the follow-up question, “well then where do I go?”

The truth is, there are quite a few places investors can go to get income that doesn’t involve unnecessary interest rate risk.  (Interest rate risk refers to the fact that if interest rates rise from their current historic lows, the value of bonds will go down – the longer the duration is on the bond, the more sensitive it will be to interest rate moves).

Some of our favorite income investments include:

• Master Limited Partnerships (MLPs)
• Business Development Companies (BDCs)
• Real Estate Investment Trusts (REITs)
• Dividend paying stocks

Let’s focus on MLPs for an example. MLPs are generally companies who are in the business of building energy infrastructure… things like pipelines, storage facilities, and other plumbing that moves energy around the country.  MLPs came about back in the 80s when Congress wanted to encourage an energy infrastructure in the US.

The most unique thing about an MLP is that it is structured as a limited partnership and not a C-corporation.  The reason this is important is because it allows the entity to not pay taxes at the corporate level.  Instead, the company is able to pass through virtually all of its profits to the unit holders (investors) without first paying any taxes.  That’s a big benefit.

Another plus is that the investor gets the income in a tax-advantaged way.  The distributions are considered “return of capital” and not dividends which means the investor doesn’t have to pay any taxes on the income received until they finally decide to sell their shares.  So depending on an investor’s tax bracket, a 6% yield being paid by the company may suddenly begin to look like 8%.

The final benefit we will talk about here is the resilient business model of most MLPs.  As mentioned above, these are companies that are in very stable, predictable business climates.  Things like pipelines and energy storage are somewhat boring and straight-forward, meaning that what you see is basically what you get.  So it’s unlikely to get any big surprises – good or bad.

There is much more to talk about in the world of MLPs, so if you’re curious and want to learn more, check out one of our favorite commentators, Bob Rice, explaining them in this short 5 min video segment from Bloomberg.

Categorized in: Blog

This post was written by Conscient Capital