Master Limited Partnerships for Income (Barrons)

SATURDAY, JUNE 2, 2012 Pipelines to Profits
By ANDREW BARY

The allure of master limited partnerships gets stronger, based on robust operating profits, tax breaks and a booming U.S. energy sector.


Master limited partnerships have been one of the best investments in the past 10 years, generating an annualized total return close to 16%, versus just 4% to 5% for the Dow industrials and the Standard & Poor's 500.

While these historical returns are excellent, the $250 billion sector has come under pressure, with the benchmark Alerian MLP Index down 9% this year. The yield stands at 6.6%.

MLPs mainly transport and store oil, natural gas, natural-gas liquids, gasoline, and other refined petroleum products. An estimated 65% of the industry's revenue comes from fees, many based on government-regulated rates. MLPs therefore offer some of the stability of electric utilities, plus growth potential tied to the construction of pipelines, plus storage and other facilities, driven by booming U.S. energy output.

MLPs are as attractive as they have been in some time," says Charles Lieberman, chief investment officer of Advisors Capital Management in Hasbrouck Heights, N.J. "Their investment opportunities are unparalleled as they expand their pipeline systems to provide access to new energy fields."

Comments Credit Suisse analyst John Edwards: "We conservatively see mid-single-digit annual growth in distributions over the next several years. Combine that with a mid-6% yield, and that looks pretty attractive, given current market conditions." Edwards says the yield gap between MLPs and the 10-year Treasury note is historically high at five percentage points, versus an average of 3.3 since 1999. That gap is skewed by the ultra-low yield of 1.5% on the Treasury, but MLPs stack up well against other yield-oriented groups, such as real-estate investment trusts and electric utilities, which yield in the 3% to 5% range.

MLPs historically have done very well when the yield gap has been around five percentage points. Edwards sees a total return exceeding 15% for MLPs over the next year.

Probably the biggest negative for MLPs is that they pay out nearly all of their cash flow in distributions, making them rely on the sometimes fickle capital markets to fund projects. This also makes the distributions vulnerable to setbacks. A drop this year in prices for oil and natural-gas liquids has hurt the sector.


Edwards favors large, well-capitalized MLPs like Enterprise Products Partners, Kinder Morgan Energy Partners, and Plains All American Pipeline, with yields in the 5% to 6% area. Lieberman is partial to higher yielders like Regency Energy Partners and Energy Transfer Partners that yield around 8%. Among high-yielding MLPs, Edwards likes Boardwalk Pipeline Partners, now at 8.2%.

MLP dividends technically are distributions, and more than 80% of the industry's payouts are tax-deferred. The taxed portion is treated as ordinary income, because master limited partnerships aren't subject to corporate taxes. The dividend's tax-deferred portion cuts investors' cost basis in MLP units (aka shares) and is subject to taxes when the units are sold, says New York tax expert Robert Willens. Many investors avoid these taxes if they hold the units until death and their estates are below the current $5 million inheritance-tax threshold.

Another minus is that investors get annual K-1 tax forms, rather than 1099s. This can result in more cumbersome and costly tax filings. The tax issue has helped spur the growth of exchange-traded funds and notes that do away with dreaded K-1s. Alerian MLP (AMLP) is the largest ETF and trades around 16, producing a yield of 6%. The drawback here is that appreciation in MLP holdings is subject to corporate taxes, dampening the upside.

The JPMorgan Alerian MLP, the largest exchange-traded note, is around $36 with a 6% yield. It offers a return linked to an Alerian index of 50 MLPs. A plus is no corporate taxation. A negative is that the shares amount to a debt obligation of JPMorgan Chase, exposing investors to credit risk, albeit limited, given the bank's strength. And the dividends are subject to ordinary income taxes. ETNs are good for investors who want MLP exposure in tax-deferred accounts like IRAs and 401(k)s. Direct MLP investing in these accounts can subject holders to certain taxes.


Big Gap, Big Opportunity
MLPs yield an average of 6.6%, five percentage points more than 10-year Treasuries. Historically, they've done well when the gap is that wide.

Enterprise Products Partners, at $48, is the largest MLP, and has good growth potential thanks to $7 billion of capital projects. Its yield is a below-average 5.1%, balanced by its growth outlook, a higher-than-average distribution-coverage ratio and distribution increases in 31 straight quarters. Edwards has an Outperform rating and a $59 price target. One plus is that Enterprise doesn't share profits with a general partner, unlike many MLPs, because it bought out its GP in 2010.

KINDER MORGAN ENERGY Partners (ticker: KMP) is big, diversified, and well-managed, with the country's largest natural-gas transportation system. But it allocates 45% of its cash flow to Kinder Morgan (KMI), its GP—one of the industry's highest GP takes.

Kinder Morgan Energy Partners trades at $78 and yields 6.3%, based on an anticipated 2012 distribution of $4.98 per unit. Its sister company, Kinder Morgan Management (KMR), is economically equivalent, but is structured as a corporation and pays the same dividend amount in stock, not cash. KMR, at $72, yields 6.9% and has traded at a persistent discount to KMP. Credit Suisse's Edwards has a $92 price target.

Plains All American, a leading oil transporter, has significant exposure to rising crude production in mid-America. "It's in the sweet spot for the infrastructure build-out theme," says Kyri Loupis, portfolio manager for MLP strategies at Goldman Sachs' investment-management division. Plains, now at 78, has a 5.3% yield. Loupis sees its distributions rising 8% annually over the next three years. He also likes MarkWest Energy Partners (MWE), which trades at 46 with a 6.3% dividend yield, because of its exposure to fast-growing energy production in the Marcellus shale in the Northeast.


Some MLPs, and an exchange-traded fund and note that invest in the sector:

Company/Ticker Recent Price 52-Wk Change 2012E Cash Flow* Price/ Cash Flow Div Yid Stk-Mkt Val (bil)
Boardwalk Pipeline Partners /BWP $25.95 -10.8% $2.11 12.3 8.2% $5.4
Energy Trans Part /ETP 43.39 -8.7 3.78 11.5 8.2 10.2
Enterprise Prods/EPD 48.76 17.1 3.63 13.4 5.1 43.3
Kinder Morgan Eng /KMP 78.33 5.1 5.19 15.1 6.1 26.2
Kinder Morgan Mgt /KMR 71.03 8.8 5.19 13.7 7.0 7.1
Plains All American /PAA 78.53 26.2 6.33 12.4 5.3 12.7
Regency Energy Part /RGP 21.52 -14.6 2.06 10.4 8.6 3.7
ETF or ETN/Ticker
Alerian MLP ETF /AMLP $15.73 -1.3% N/A N/A 6.2% $3.2
JPMorgan Alerian ETN /AMJ 36.54 -0.5 N/A N/A 5.7 4.1
*Per Share E=Estimate N/A=Not Applicable
Sources:Thomson Reuters; Bloomberg; Credit Suisse; JPMorgan
.
.DIMITRA DEFOTIS contributed reporting for this article.

Master Limited Partnerships for Income (Barrons)

Master Limited Partnerships



: A Good Place to Get 6% Payouts
By DIMITRA DEFOTIS
Five energy plays that could stoke your portfolio.
Every day, a veritable ocean of oil cascades through thousands of miles of pipelines crisscrossing America, making its way from shipping ports and exploration fields to refineries and end users. A similarly vast tangle of pipes does the same kind of job for natural gas. And then there's the pipeline for investors.

Master limited partnerships, which typically process oil and gas, store it and move it through pipelines, are producing some of the best yields anywhere -- typically 6% and sometimes more. And the outlook for these ventures is excellent.

MLPs pay out most of their cash flow as dividends, or "distributions." MLPs are exempt from corporate taxes. But investors are taxed on some of their distributions annually. Taxes on the rest are deferred until units are sold. In the meantime, the structure can provide hefty payouts year after year, and the deferred tax burden disappears at the unit holder's death -- making the MLP an attractive wealth-transfer tool.

The industry, which has assets of about $250 billion, should have plenty of growth ahead. Traditional energy companies are likely to sell more assets to MLPs for the tax savings and yield. In addition, partnerships have ample borrowing capacity to fund expansions. The profits from all that will flow to investors through payouts.

Yes, there are risks. MLP unit prices are on the high side right now, and payouts could suffer as interest rates and borrowing costs rise. Still, some of the sharpest investors in the field are expecting double-digit total returns for some time to come.

"If you look at where MLPs are trading relative to similarly risked assets, we think the yield is attractive," says Terry Matlack, co-founder of Tortoise Capital Advisors, which manages MLP closed-end funds. "The sector continued to grow distributions through the teeth of the economic downturn."

ANY FURTHER IMPROVEMENT in the economy would help MLPs by lifting demand for energy. Plus, a recent federal tariff increase has brought about clarity on pipelines' pricing in the coming years, says Kyri Loupis, who directs MLP strategy within Goldman Sachs' investment-management division. He holds several pipeline players, including Plains All American Pipeline (ticker: PAA), Magellan Midstream Partners (MMP) and El Paso Pipeline Partners (EPB).

Houston-based Plains transports, stores and markets crude oil, liquefied petroleum gas and related products. The current rise in oil prices could give the stock a nice nudge. Because futures prices of oil right now are higher than the current price, companies like Plains that can store crude and sell it later have greater power in negotiating storage fees.

Plains is the largest operator of storage in the energy hub of Cushing, Okla., and also has storage in Illinois that can hold Canadian crude. Plains pays a 5.9% yield, and brokerage house Stifel Nicolaus thinks distributions per unit could increase 4% in 2011, boding well for the yield.

Magellan, based in Tulsa, Okla., stores and transports refined petroleum products. It expects 7% growth in its annual distribution in each of the next two years, a growth rate that should exceed the sector average, Loupis says.

Magellan is attractively priced: Its enterprise value (market value plus net debt) is 13.3 times its adjusted Ebitda (estimated earnings before interest, taxes, depreciation and amortization, all adjusted for earnings paid to a general partnership), below the industry average of 14.3. Its yield is 5.1%, according to Wells Fargo. Plains is trading at an adjusted Ebitda multiple of 20.5, but pays a higher yield.

The largest energy partnership around, with a market capitalization of $36.5 billion, is Houston-based Enterprise Products Partners (EPD). It operates thousands of miles of pipelines, and processes and stores natural gas, oil and related products. Enterprise has been making some promising moves and, in the process, streamlining a convoluted operating structure, says portfolio manager Tom Cameron, who allocates about 20% of the Rising Dividend Growth Fund (ICRDX), to MLPs.

Enterprise has absorbed its general partner; merged with Teppco Partners, a pipeline company spinout; and recently announced its intention to merge with Duncan Energy Partners, a pipeline MLP. Enterprise Products isn't particularly expensive, with an enterprise value to Ebitda multiple of 13.8. Its yield is 5.4%.

The beauty of pipelines is that they collect steady fees based on volume, rather than volatile commodity prices. Natural-gas pipelines are all the more attractive as the country increasingly turns to this clean-burning form of energy. Natural-gas pipeline operators like El Paso Pipeline stand to benefit handsomely. This MLP was carved out of the exploration and production company El Paso in 2007. The parent still has pipeline assets that it's likely to "drop" into the tax-efficient MLP structure, a practice that has increased distributions 50% since 2007. El Paso's yield is 4.7%, and it looks reasonably priced with an enterprise value to Ebitda of 13.4.

Beyond pipelines, there's a coal play worth a look: Natural Resource Partners (NRP), a Houston-based MLP. Formed in 2002 with properties sold by U.S. railroads and coal companies, NRP leases land to America's biggest coal companies. Its land produces 5% of all U.S. coal and its contracts wisely hedge against drops in coal prices.

NRP is now acquiring 200 million tons of coal reserves in the Illinois basin, with production beginning in 2012. That should contribute to 5% to 6% annual distribution growth starting in 2012, according to Dallas-based Swank Capital. NRP trades with a multiple of enterprise value to Ebitda of 16.2, and its yield is 6.1%.

Investments like these could be just the thing to fire up your income.

.E-mail: editors@barrons.com

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Investing in Master Limited Partnerships (WSJ)

AUGUST 10, 2010 Frenzy in Energy Partnerships
Investors Stick Billions of Dollars Into a Stock-Market Niche Known as MLPs
By TOM LAURICELLA And CAROLYN CUI
Lured by hefty yields, investors are pouring billions of dollars into a small corner of the stock market—energy-focused master limited partnerships—which has seen a huge rally of 15% this year. And that makes some people nervous.

MLPs are mostly companies that own and operate pipelines, primarily for natural gas and oil. Benefiting from the tremendous expansion of energy infrastructure in the U.S., MLPs essentially collect rent from energy producers who use their facilities.


Over the past decade, the Alerian MLP index, the main benchmark for the group, is up about 11% a year. That is a handsome payoff compared with the Standard & Poor's 500-stock index, which is down 2.6% a year. Their major appeal is payouts to investors these days averaging around 7% a year at a time when bond yields are at all-time lows. MLPs are expected to increase those distributions by another five percentage points or so a year.

But the recent surge in popularity of MLPs may be adding a new element of risk to the group. The Alerian index, including distributions, has returned 21% in 2010 without any meaningful change to the sector's fundamental outlook. Instead those gains are seen as being fueled by the rush of new money into the sector. Meanwhile, most MLP funds concentrate their portfolios in a handful of the same stocks. The end result is MLPs could be growing vulnerable to a decline in prices.

"We think the sector is a bit frothy in the short run," said Ethan Bellamy, an analyst at Wunderlich Securities Inc.

The big yields of MLPs are the result of their corporate structure. While they trade like stocks, the companies generally distribute all their profit to shareholders because of their limited partnership status. Better yet, those distributions usually aren't taxable until investors sell the shares.

Another selling point for MLPs is their diversification. They have low levels of correlation to the rest of the stock market and to U.S. Treasurys. In June, for example, when the S&P was down 5.2%, the Alerian index was up 5.6%.
MLPs have changed markedly over the years. In their early days in the late 1980s, the underlying businesses ranged from hotels to basketball's Boston Celtics. But concerns were soon raised that some companies were exploiting MLPs to avoid taxes. Laws were tightened and MLPs are now limited to energy and certain natural-resource companies, mainly pipelines and storage for natural gas and oil.

The proliferation of MLP funds started with the launch in June 2009 of the J.P. Morgan Alerian MLP Index Exchange Traded Note, which has pulled in $1.6 billion. On March 30, SteelPath Advisors, an offshoot of Alerian, opened the doors on three MLP mutual funds that have taken in nearly $300 million.

But the floodgates have really opened in the past two months. Legg Mason's Clearbridge unit and MLP veterans Tortoise Capital Advisors each launched MLP closed-end funds and attracted more than $2 billion from investors. With leverage, the funds will be investing some $2.7 billion. And still more funds are in the works, including an exchange-traded fund.

All this money is pouring into a small space. There are roughly 70 MLPs with a total market value of about $200 billion. Only about three dozen of those names trade actively. And the Alerian benchmark is heavily concentrated; the top five names comprise 41% of the index.

At Tortoise, for example, the firm's new $1.1 billion Tortoise MLP Fund, which hasn't yet disclosed its holdings, will specialize in natural-gas MLPs. But its two other biggest funds already have about 52% of their combined $2 billion in assets in natural-gas MLPs. And many of those names are big holdings in the Alerian index.

"Everybody's buying the same top 10," says Jason Stevens, who follows MLP stocks for Morningstar.

Meanwhile, the performance of MLP stocks has been extremely uniform, suggesting little differentiation by investors among individual MLPs. Among 10 oil-pipeline MLPs tracked by Wunderlich Securities as of Aug. 4, seven are up 29% to 41% in the past year, and another two are up 20% or more.

Jerry Swank, founder of Dallas-based Swank Capital LLC, which manages an MLP portfolio of $1 billion, says he is concerned about "a temporary imbalance between supply and demand" that could potentially reverse into a selloff.

The rally already has pushed down yields. A year ago, MLPs on average yielded 8.8%, but that has dropped to 6.3%, Wunderlich Securities says.
Michael Blum, an MLP analyst at Wells Fargo Securities LLC, figures MLPs are trading at a multiple of 11.8 compared with 12 over the past five years using discounted cash flows, the standard metric for valuing MLPs.

"MLPs look fairly valued," Mr. Blum says.

But valuation concerns mightn't prove a deterrent as investors chase distributions and growth that have yielded far more than other investment options.

"We see the typical MLP increasing its distributions by 5% a year," said Morningstar's Mr. Stevens. "And if you've got securities yielding 6% to 8% … you can lock up a 12% gain."

Supporting that optimism is that MLP clients sign long-term contracts, often for 10 or 15 years. Those contracts often contain clauses that increase the fees paid to MLPs to adjust for inflation.

Still, the longer-term outlook for MLPs isn't risk-free. MLPs increase their distributions one of two ways: They either build or buy new pipelines and storage facilities. Both avenues require tapping the stock or bond markets to pay for their expansion. Any interest-rate increase will result in higher borrowing costs and potentially smaller payouts for investors.

And their tax-deferred appeal could be at risk if Congress revisits their tax status. Says Christopher Eades, a portfolio manager on the Clearbridge Energy MLP Fund: "An investor in MLPs has to watch what's going on in Washington extremely carefully."
Write to Tom Lauricella at tom.lauricella@wsj.com and Carolyn Cui at carolyn.cui@wsj.com

Where to Find Higher Yield (Kiplingers Magazine)

Great rates in a low-yield world

BY Jeffrey R. Kosnett, Kiplinger's Personal Finance — 06/01/10

You're earning zilch on your savings. No sweat. We offer 18 investments that pay 5% or more.
A year ago you needed the nerves of a tightrope walker to buy any income security that didn't include the word Treasury in its name. Prices for just about everything else -- including corporate debt, real estate trusts and preferred stocks -- had been so pummeled that you could have been excused for thinking America was going out of business.

But, as we now know, this was a spectacular buying opportunity. Once credit markets thawed and investors gained confidence that a depression had been averted, just about every yield-oriented investment outside the comfort zone of Treasury bonds staged a rally for the ages. Over the past year, for example, junk-bond funds have gained nearly 50% on average, and the typical real estate fund has returned nearly 100%. Some preferred stocks of troubled banks have quintupled.

As a result of this remarkable rebound, high-income stocks, bonds and funds are no longer steals. But many still pay far more than the bupkis you get from money-market funds, and they outyield Treasury bonds, too. Plus, today you can buy high-yielding securities without assuming especially large risks. Continuation of a slow economic recovery should boost the fortunes of corporations and state and local governments without pushing up inflation, which would lead to higher interest rates in the bond markets -- and lower prices for many kinds of fixed-income securities (bond prices and interest rates move in opposite directions). Below, we list 18 investments that yield 5% or more, in ascending order of risk.

Taxable munis
In little more than a year, cities, states and public agencies have issued $100 billion of taxable Build America Bonds. BABs pay extraordinarily high interest rates because Uncle Sam, as part of the 2009 financial-rescue package, picks up 35% of the issuers' interest costs. BABs now yield more than corporate bonds with like maturities and credit ratings, making them great not just for IRAs and other tax-deferred accounts, but for taxable accounts as well.

Yields of at least 6% are common for new, long-term BABs. The state of Illinois, for example, just issued 25-year BABs at 6.6%. These are general-obligation bonds, backed by the state's taxing power. Standard & Poor's rates Illinois A-plus, although the state is on watch for a possible rating downgrade. If you prefer to lend to an entity that appears to be in better shape, consider a new, 30-year New York City water-and-sewer revenue bond. The BAB, rated double-A-plus, hit the market at 6.4%.

Fans of exchange-traded funds should consider PowerShares Build America Bond ETF (BAB , $25). With an average credit quality of double-A, it pays dividends once a month and yields 6.2% (all prices and yields are as of the April 9 close).

Preferred stocks
A preferred stock is closer in spirit to a bond than a common stock because a preferred dividend is almost always fixed. So if long-term interest rates rise, a preferred reacts like a bond and loses value. You also face company risk should the issuer run into trouble and suspend preferred dividends. If you can stand some price fluctuation, consider reinsurer Endurance Specialty Holdings 7.75% Preferred (ENH/PA , $24). Rated triple-B-minus, the issue is not callable until 2015 and sports a current yield of 8.1%. Under current federal law, the top tax rate on qualified dividends is just 15%. (Many stocks that look like preferreds are actually hybrid securities and aren't eligible for preferential tax treatment.)

Banks, insurers and real estate investment trusts are the most common issuers of preferreds. With a preferred-stock ETF, you can diversify into utilities and industrials. The oldest and largest among these is iShares U.S. Preferred Stock Index ETF (PFF , $39). It pays dividends monthly and yields 6.5%.

Juicy dividend payers
The overall U.S. stock market yields less than 2%, but you'll find plenty of profitable, blue-chip outfits that pay far more and are willing to maintain and even raise their disbursements. The best sources of fat dividends are utility, energy, drug and consumer-products companies. Should the economy start to weaken again, at least three of those sectors -- energy being the exception -- should hold up relatively well.

Shares of two telecommunications giants offer exceptionally generous yields. AT&T (T , $26) and Verizon (VZ , $30) recently yielded 6.4% and 6.3%, respectively. Although drug makers remain extremely profitable and have continued to pass out gobs of cash, their share prices have been stagnant for years, resulting in high yields. Our favorite for dividends: Eli Lilly (LLY , $37). Lilly has boosted its distribution 28 straight years, yet still pays out only half of its earnings. Its stock yields 5.3%.

Traded partnerships
Master limited partnerships are limited partnerships that trade on exchanges like stocks. MLPs pay no corporate taxes, so they can pay ample income to investors. On the downside, MLPs can add extra work when you prepare your taxes. Our favorite MLPs are those that own pipelines and energy terminals. They earn predictable fees and rents, rather than depend on the price of raw materials and refined fuels. Historically, these kinds of MLPs have yielded three to four percentage points more than Treasury bonds. That means they should yield 7% or higher today.

If you screen for MLPs that carry less debt than their peers yet still offer superior yields, two that stand out are Boardwalk Pipeline Partners (BWP , $30), which yields 6.7%, and Copano Energy (CPNO , $26), which yields 8.9%. Boardwalk owns three pipelines and 11 underground natural-gas storage fields; Copano operates gathering and transmission pipelines for gas producers in Louisiana, Oklahoma, Texas and the Rocky Mountains. An alternative to individual MLPs is Kayne Anderson MLP (KYN , $27), a closed-end fund that uses leverage (borrowed money) and has investments in 45 pipeline and storage MLPs (closed-end funds trade like stocks). Kayne Anderson recently yielded 7.1%, even though the shares traded at a 10% premium to the fund's net asset value. If you can buy the fund at a smaller premium -- or better yet, a discount -- pounce.

Treats With REITs
Beyond the fact that they were dirt-cheap near the end of the financial crisis, it's hard to explain why real estate investment trusts have performed so spectacularly. Most REITs own properties, such as office buildings, shopping centers, warehouses and posh mixed-use developments, that are hungry for buyers and tenants. Rents in many categories are flat or falling. REITs carry a lot of debt.

Still, you can find a few outliers that yield at least 5% and are reasonably safe. REITs that own health-care properties come to mind. Unlike offices and hotels, which are closely tied to the overall health of the economy, medical property is a growth business. And REITs own only 6% of U.S. health-related property, while they own 12% of all commercial real estate. So as health care assumes a greater share of the economy, medical REITs will have plenty of opportunities to build and buy. One of the best REITs in this sector is Health Care REIT (HCN , $46), which owns a wide range of facilities, including hospitals, nursing homes and medical-office buildings. It yields 6.0%. Another good choice is LTC Properties (LTC ), a much smaller REIT that owns nursing homes and assisted-living facilities in some 30 states and yields 5.5%.

Outside of health care, consider Realty Income (O ), a retail-property REIT that signs tenants to triple-net leases. These require clients to pay for property taxes, insurance and maintenance as well as rent. Realty Income has high occupancy and low debt, and it has paid monthly dividends for 40 years. It yields 5.4%.

One of a kind
Although it's set up as a REIT, Annaly (NLY , $17) owns no property. Rather, it borrows at short-term rates and invests the proceeds in medium- to long-term government-guaranteed mortgage securities. As long as the Federal Reserve holds short-term rates near 0% (1% would be okay), Annaly earns a bundle. And because it's a REIT, it must pay out at least 90% of its net income to shareholders. Over the past four quarters, it has paid $2.69 a share, which works out to a yield of 15.6% at the current stock price.

Normally a yield that high is a warning to stay away. But because Annaly's portfolio contains only government-backed securities, you needn't fear a rash of loan defaults. "This isn't glamorous or sexy," says Greg Merrill, a Seattle investment manager and a big fan of Annaly. "In fact, it's boring." Nothing wrong with that.

High-yield closed-ends
This category requires caution. Some high-paying closed-end funds aren't actually earning the amount they pay out (you can glean this sort of information from fund shareholder reports). Take a pass on those. However, others cover their high distributions with real earnings and income. If you invest at or below net asset value -- a wise idea when buying any closed-end -- you get good income at a fair price.

MFS Special Value Trust (MFV , $7) invests in an unusual combination: junk bonds and high-yielding stocks. It doesn't use leverage to enhance returns, but that doesn't mean it's a low-risk fund. It lost 35% on assets in 2008 and then gained 58% in 2009 (because investors become more enthusiastic about closed-ends in up markets and tend to unload them in down markets, the swings in performance based on share price were even more dramatic). The fund pays dividends every month from capital gains and interest income. It recently traded within a few cents of its NAV and is on track to distribute 69 cents a share this year. At the current price, that puts the yield at 9.5%.

Strategic Global Income (SGL , $11) has what's known as a managed-distribution policy. The fund, which doesn't use leverage, pays out 7% of NAV each month, using interest income and capital gains to cover the distributions. It's a go-anywhere bond fund, so the managers explore all sorts of investments, but their record has been decent over the past few years. The fund lost a modest 11% during the 2008 disaster, then staged a powerful 40% advance in 2009. The shares trade at a 10% discount to NAV, which explains why they yield 7.8% -- more than the distribution rate.


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All Contents © 2010 The Kiplinger Washington Editors

Master Limited Partnerships for Income (WSJ, AP)

WEEKEND INVESTOR APRIL 10, 2010

Big Yields, Big Risk in the Oil Patch
Master Limited Partnerships Are Luring Investors for Their Yields and Growth Potential, but Can Plunge When Rates Rise
By TOM LAURICELLA
(See Corrections & Amplifications item below.)


Associated Press

Shares of the master limited partnership have risen more than 11% so far this year.
Yield-starved investors are piling into a small corner of the financial markets sporting big payouts: master limited partnerships. But they should tread carefully. While these energy-related plays are seen as having strong prospects, they also are volatile, and have a history of being tripped up by higher interest rates.

Master limited partnerships, or MLPs, are essentially energy companies that own and operate pipelines and storage facilities for natural gas and oil. They generate revenue by essentially collecting fees from energy exploration and production companies that use their properties.
While the securities issued by MLPs are technically stocks and trade on exchanges, MLPs are unlike most other publicly traded companies. Rather than being structured as corporations, they are partnerships, which means they generally pay out all the cash they generate to shareholders as income.
Those yields are central to MLPs' appeal. On average, MLPs are yielding roughly 7% right now, an unusually high level of income in today's market. In contrast, the stocks in the Standard & Poor's 500-stock index generate dividend yields of only 1.9%, on average. Also central to MLPs' appeal: the increasing development of oil and natural-gas infrastructure in the U.S.

Those two factors have helped fuel the main MLP benchmark, the Alerian MLP Index, to a 19.6% annualized gain over the past decade and a 10.8% rise so far this year. The combination of the high yield and big returns has investors pouring money into the sector. The JPMorgan Alerian MLP index exchange-traded note, launched in March 2009, has attracted $1 billion already.

But in the short-term, external factors can make MLP prices volatile. Because of their big yields, "Many people mischaracterize them as a bond replacement, which they are not," says Shawn Rubin, an adviser at Morgan Stanley Smith Barney who has used MLPs for some clients for a decade. "Although they have a yield component, and hopefully a growing yield … the price fluctuations definitely look more like stocks than bonds."

To a large degree MLPs are creatures of Congress's whims and the tax code. As a result, they have changed over the years. In their early days in the late 1980s, the underlying businesses were all over the map, from hotels to the Boston Celtics. MLP laws were soon tightened. Today they are limited to energy firms, mainly pipelines and storage for natural gas, oil and biofuels.


The universe of MLPs remains relatively small, with 69 publicly traded companies today, up from fewer than 30 a decade ago, according to Alerian. MLPs carry a total market capitalization of $150 billion, and just five companies account for more than 40% of the sector's value, according to Alerian's data. By contrast, Exxon Mobil's market value alone is more than $300 billion.

The long-term bullish case for MLPs centers on expectations for a boom in pipeline and storage in the U.S., especially as new natural-gas fields come into production. That in turn could lead to increases in MLP payouts.

But a look at their history shows the short-term damage that can come from rising interest rates. During MLPs' relatively short history—most didn't exist a decade ago—investors have tended to suffer sharp losses when the Federal Reserve began raising rates, as it is expected to do beginning later this year. For example, in late January 2004 the Fed signaled that an interest rate rise was on the way. The Alerian index fell 4% in a little over a week, recovered and then went into a swoon that took it down 12% from its January high. MLPs also sank after the Fed tightened in 1999 and lost 14% for the year.
One reason for their interest-rate sensitivity is that MLPs increase yields by adding assets, either through acquisition or building from scratch. In either case, MLPs must raise funds for their expansion by tapping the stock or bond markets. As a result, higher interest rates can increase their cost of capital. And if higher rates lead to a slowing economy, that in turn could damp their growth.
But over long periods in which the Fed has raised rates, MLPs have generally recovered well. During the two-year tightening cycle of 2004 through 2006, the Fed raised the federal-funds rate to 5.25% from 1% and MLPs gained 48% between May 2004 and July 2006, data compiled by Kayne Anderson show.

Morgan Stanley's Mr. Rubin says that he is stressing yield-paying investments and, as result, in cases where he might normally recommend 5% of a portfolio be in MLPs, today's he is recommending a 10% stake.

"I'm willing to deal with the variation in price," Mr. Rubin says. Given the potential for long-term increases in MLP yields, "I'd use those interest-rate sensitive pullbacks as moments in time to be a buyer."

Corrections & Amplifications

Master limited partnerships pay out cash they generate to shareholders as ordinary income. A previous version of this article incorrectly described their payouts as dividends.

Write to Tom Lauricella at tom.lauricella@wsj.com

Dividends and Taxes (Morningstar)

Dividends and Taxes: Dos and Don'ts

DividendInvestor editor Josh Peters goes over the basics of dividend tax treatment and highlights some potential pitfalls for MLP investors.

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. It's that time of year again, that investors are worrying about their taxes, and a question on a lot of people's mind is how dividends are taxed.

Here to discuss it with me is the editor of Morningstar DividendInvestor, Josh Peters. Josh, thanks for joining me.

Josh Peters: Happy to be here.

Glaser: Could you talk a little bit about the different types of dividends and income that investors could see and how those are going to be taxed?

Peters: Sure. When you're looking at common equities, they really fall into three categories. The first is the largest category by far, which is common stocks of traditional, what we call C corporations.

These corporations themselves pay federal income taxes. If they pay a dividend, because that corporation is paying income tax before it even has the opportunity to send a dividend to you, they're what are known as qualified dividends. And for federal income purposes, the tax rate is capped at 15%.

Then there is another group of very popular higher-yielding stocks, perhaps not so popular after the crash, but real estate investment trusts, or REITs. These are not eligible for the qualified dividend treatment because REITs themselves don't pay federal income taxes.

They're exempt from income taxes as long as they pay out at least 90% of their taxable income to their shareholders, so it's the shareholders who wind up being taxed on that income. Those dividends you have to pay tax at your ordinary tax rate, whatever your marginal tax rate is for the particular year.

And then there's another category called master limited partnerships. And these technically are not corporations at all and what you get are actually not even called dividends, they're just called generically cash distributions. In this case, like REITs, master limited partnerships don't pay federal income taxes.

Instead, what they do is they divvy up their taxable income to shareholders, actually technically partners, via a schedule K-1 that you receive in the mail, usually sometime in March. And it's those figures that you consolidate onto your tax return and that is the basis for what you might have to pay tax on, and if you owe tax, then it's paid at your marginal tax rate.

Glaser: What happens if you own these companies in an IRA or some other tax-advantaged account?

Peters: Well, with both the qualified dividend payers and the REITs, to own them in a tax-deferred account is advantageous because you're not obliged to pay tax on those earnings when you receive them. You have the opportunity to reinvest the whole thing and increase your income by owning more shares of a particular company, particular REITs, whatever the case may be, and you are only taxed when you make a withdrawal from the account.

Master limited partnerships, though, it's a little different story. Even though REITs are allowed to pay dividends into tax-deferred accounts and they themselves are not paying federal income taxes, master limited partnerships are taxed in a very, very different way, a whole different part of the tax code. And the government doesn't like for those income allocations to be made to tax-exempt entities. And it isn't just IRAs, it's even things like charitable trusts, are really not able to receive that partnership income.

It's not technically illegal, but in a worst-case scenario, if you receive more than a certain amount of master limited partnership-allocated income in an IRA, your IRA would owe tax and have to file its own tax return. You might have to cut a check from your IRA to pay tax that you would've owed as a regular taxable shareholder of a master limited partnership. So it gets very messy. My recommendation is to just not do it.

Glaser: So even if your broker says that you can do it, definitely something to stay away from?

Peters: Anybody who says that you can do it or there's a good way to get away with it, I would check with a tax advisor first because the way that master limited partnerships work is that you may be allocated, in fact, taxable losses, have no taxable income even though you're receiving cash distributions in the first couple of years you own a partnership because there's all these big depreciation charges that are front-loaded and you get the benefit of those up-front.
But later on, as those depreciation deductions become less valuable, that taxable loss that you might be allocated is turning into taxable income. And then if you should sell, all of a sudden there's a big catch-up provision where all of the excess depreciation deductions that you might've had or losses that you might've been allocated any particular year, those are all trued up to what you actually got for selling and you could find yourself with a big one-time gain just from a purely tax book perspective. And that's not the kind of situation that you want to run into.

I'm not going to say it's illegal, I'm not even going to say, you know, don't do it ever, ever, ever, but you have to be very, very careful because the limit, $1,000 a year worth of non-qualifying income in an IRA, is low. Even a relatively modest investment, if it turns out to be successful, could bump up against that limit.

Glaser: OK, great. Josh, thanks so much for talking with me today.

Peters: Yeah. Sorry this is so complicated, but just keep in mind, if you remember that MLPs really don't belong in IRAs or 401(k) plans, Roth accounts, things like that, you might save yourself some big headaches down the road.

Where the Yields Are (Barrons) MLPs, preferreds, dividend stocks

BARRON'S COVER 12/7/09
Even Better Than Bonds

By ANDREW BARY


With bonds fully priced, it may be time to swap into preferred shares, utility stocks and other investments that produce income but offer protection if interest rates rise.




TIRED OF THE PUNY YIELDS ON YOUR BONDS? Worried that interest rates and inflation will rise, clobbering their prices? Now may be the time to start moving into high-yielding stocks, while scaling back fixed-income holdings.

Bonds rode the price roller coaster up as interest rates fell. They could take a scary plunge if rates shoot up.
This means buying utility and telecom stocks, which have lagged behind the overall stock market this year, as well as master limited partnerships focused on the transportation of natural gas and oil-related products. Other alternatives to traditional bonds include bank preferred stock and convertible securities.

In contrast to bond yields, many of which are near multi-decade lows, yields on these alternatives often run in the 5%-to-9% range. The underlying investments also offer the potential for capital gains and rising income to offset inflation. In addition, income from most of these investments now benefits from favorable tax treatment.

Chuck Lieberman, chief investment officer at Advisors Capital Management, a Hasbrouck Heights, N.J., investment advisor, calls this "investing for income with growth. This strategy offers growth of income and principal, in contrast with a fixed-income portfolio." Lieberman is partial to master limited partnerships, high-dividend stocks, preferred shares and convertibles. Another alternative to U.S. bonds is foreign sovereign debt, which offers a hedge against a weakening dollar.

Master limited partnerships could be the past decade's quietest investment success, generating annualized returns of 18%, against 15% for gold and about zilch for the Standard & Poor's 500. While the MLP market has rallied sharply this year, major operators like Kinder Morgan Energy Partners (ticker: KMP), Enterprise Products Partners (EPD) and Boardwalk Pipeline Partners (BWP) still yield 7% to 8% and have good growth prospects.
Bill Gross, the managing director of Pimco, the giant bond manager, wrote recently in his monthly commentary that electric-utility stocks looked attractive. He noted that their dividend yields now exceed those on utility bonds, while offering the added benefit of more favorable tax treatment than bond interest. "Growth in earnings should mimic the U.S. economy as it always has, and importantly, utilities yield 5% to 6%, not 0.01%," Gross wrote, the 0.01% yield referring to the pitifully low yields on money-market funds.

The two major U.S. telecom operators, Verizon Communications (VZ) and AT&T (T), have trailed the S&P this year and their shares yield more than 6%. Preferred stock from Bank of America, Citigroup and Wells Fargo yield 8% to 9%. Those yields are down from the teens at the market's bottom in March, but still look attractive, given the banks' improving balance sheets and a recovering economy.

Many investors view the stock market as a minefield and the bond market as a haven. But at very low yield levels, bonds become dangerous. "If there is a little bit of a bubble somewhere, it's in the bond market," Lieberman says.

The "safest" part of the market, Treasuries, seems to be the most overvalued, and high-grade corporate bonds don't look much better. Treasury yields range from just 0.85% on two-year notes to 4.4% on 30-year bonds, while high-grade corporates generally offer 3% to 5%. Federally backed mortgage securities also look unattractive at 4% yields. These securities are apt to return little or nothing after inflation and taxes.

While investors are apt to have their principal repaid if they hold their bonds until they mature, they will suffer losses if rates rise and they sell prior to maturity. As for investors in bond funds, they typically have no guarantee of getting their money back. And the funds often levy stiff management fees on their holdings.

Vanguard is an exception, but even with the help of low fees, its big mortgage and muni funds don't yield much. Both the $37 billion Vanguard GNMA Fund (VFIIX) and the $26 billion Vanguard Intermediate-Term Tax-Exempt Fund (VWITX) yield about 3%. These funds carry annual expenses of less than one-quarter of a percentage point, roughly a quarter of what their rivals charge. It's tough to justify taking a fee of a percentage point for a fund invested in 3% or 4% securities, but many fund companies do.
Low yields haven't prevented a stampede into bond funds, which have had more than $40 billion in net inflows during each of the past three months from risk-averse investors who have been pulling money from domestic stock funds.

The Treasury and mortgage markets look particularly vulnerable because they are being supported by the Federal Reserve's keeping short rates near zero and by its purchases of these securities. The Fed's $1.25 trillion program to buy mortgage securities is due to end March 31.

Essentially, bond investors are giving cheap money to American business, the Treasury, new home buyers and overleveraged homeowners. The game may end badly for bondholders because rates are apt to rise in 2010 and 2011 from what appear to be artificially low levels.

The municipal market, a favorite of individual investors, looks overpriced for maturities of under 10 years, where yields are under 3%, and fairly priced for long-term maturities, where yields are around 5%. To get yields close to 6%, investors must buy dicier debt like that of California.

Many investors are chasing the junk-bond market, but the 50%-plus returns seen there this year will be unattainable in 2010, because yields have dropped to an average of 8% from 20% at the start of 2009. Yields on money-market funds are at or near zero, effectively resulting in a confiscation of investor money after inflation.

Real-estate investment trusts have attracted yield seekers, too. But REITs, up nearly 50% in the past 12 months, are no longer a bargain. Green Street Advisors, a Newport Beach, Calif., advisory firm, recently termed them "pricey," in part on high valuations based on earnings relative to the S&P 500. Public-market values of real estate also are high compared with those in the private market. REIT dividend yields are averaging just 4%, and fundamentals in many sectors, including apartments and office buildings, look weak. Net operating income could fall in 2010 for the second straight year.

With all that in mind, here's a look at some sectors that do provide decent yield alternatives to traditional bonds:

MASTER LIMITED PARTNERSHIPS: This $100 billion group is dominated by companies like Kinder Morgan, Enterprise Products and Magellan Midstream (MMP), which transport natural gas, jet fuel, heating oil, gasoline and other petroleum products.
Despite generating some of the best returns of any asset class in the past decade, MLPs are unfamiliar to most investors. That ought to change, because MLPs now provide 7%-to-8% dividend yields, and much of that income is tax-deferred. Dividend growth could run in the mid- to-high-single-digit range in the coming years, resulting in total annual returns above 10%. Kinder Morgan, one of the largest pipeline MLPs, recently said it will pay $4.40 in distributions in 2010, up 5% from 2009's level. Its shares, at 56, yield 7.8%, based on the expected 2010 distribution.

"Think of an analogy to toll roads," suggests Lieberman. "Pipelines are expensive to build, but operating costs are relatively low, which means they generate outstanding cash flow that services debt and finances sizable distributions to owners." Pipelines are utility-like because their rates often are set by federal regulators.

Pipeline shares were slammed in late 2008 because of concern about reduced access to the capital markets. MLPs rely on equity and debt financing for expansion, as they typically pay out nearly all their annual cash flow in dividends. The fears about market access didn't materialize and the stocks have come roaring back with the Alerian MLP Index (AMZ) up 65% in 2009 (with dividends included).

For many large master limited partnerships, 70% or more of their dividends -- technically distributions -- are tax-deferred. That's because dividends usually are far greater than reported net income, largely as a result of noncash depreciation expenses.

Let's say an MLP pays a $2 annual dividend, 80% of which is tax-deferred. An investor would owe income taxes on only 40 cents of that dividend (but the 40 cents would be taxed at regular-income rates, not the preferential dividend rate). The other $1.60 wouldn't be taxed and instead would reduce the investor's cost. If the investor paid $25 a share for an MLP, the cost basis would be reduced to $23.40. Taxes would be paid on the $1.60 when the shares are sold.

Many investors -- particularly the elderly -- simply hold MLP shares, with the intention of putting them in their estates. This essentially results in permanent tax deferral and a muni-like income stream, if the investor's estate isn't subject to federal inheritance taxes. Taxes on the sale of a long-held MLP can be high because an investor's cost basis can drop toward zero after many years of dividends.

MLPs are best held in taxable accounts: they can cause tax headaches in IRAs and other tax-deferred accounts. Investors need to know that they will get an annual K-1 tax form, not a standard 1099, and that can complicate annual filings. Another wrinkle: MLPs often share annual income gains with general partners, or GPs, some of which are publicly traded. This can limit dividend increases. Magellan Midstream has an advantage because it has combined its limited and general partners, meaning there is no GP to cut into the income allocated to the limited partners.

Utilities: Because they're seen as defensive, utility stocks have trailed the market. The Dow Jones Utilities Average has risen just 4% this year, versus a 22% gain for the S&P 500. But investors are warming to utilities, which rose 3% last week.

Until recently, the sector has been held back by various factors, including reduced power consumption, that have dampened profits at Midwestern utilities like First Energy (FE) and American Electric Power (AEP) that have a lot of industrial customers. Another negative has been the plunge in natural-gas prices, which has reduced the price advantage that nuclear utilities like Exelon (EXC) had over gas-fired rivals.

Regulated utilities, such as American Electric Power (AEP), Duke Energy (DUK), PG&E (PCG), Consolidated Edison (ED) and Southern Co. (SO), trade around 13 times projected 2009 profits and roughly 12 times estimated 2010 net, a discount to the S&P 500. "This is a safe level of valuation, and a lot of bad news already is discounted," says Hugh Wynne, utility analyst at Sanford Bernstein. Wynne, who notes that utility dividend yields average close to 5%, favors laggards such as Exelon and FirstEnergy, as well as PG&E.

PG&E, at 43, trades for 13 times projected 2010 profits of $3.42 a share. The other big California utility, Edison International (EIX), also looks appealing, trading near 35, or 10 times next year's estimated earnings. Bulls argue that the company's regulated utility business is worth almost as much as the stock price and that investors effectively are paying little for its independent power division, Edison Mission Group, whose profits have been hit by weak power prices.

As an alternative to individual stocks, investors can buy the Utilities Select Sector SPDR (XLU), an ETF that trades around 31 and yields 4.1%. Several closed-end funds focus on utilities. One is Cohen & Steers Select Utility (UTF), which at its recent price near 15 -- an 11% discount to its underlying net asset value -- was yielding 6%.

TELECOM SHARES: Verizon and AT&T have perked up lately, although their slight losses this year leave them way behind the market. The telecom business faces greater challenges than electric utilities because Americans continue to cut the cord to wireline phones, eroding a once-lucrative business. Yet both companies remain financially solid, trade for low valuations, carry juicy dividends around 6% and are strong players in the wireless market. Reflecting its control of the country's top wireless operation, Verizon, at 32, trades for about 13 times projected 2010 profits of $2.45 a share. AT&T, at 28, fetches 11 times estimated 2010 cash earnings of $2.50, which exclude about 25 cents of goodwill amortization from acquisitions.

Other high-yielders among big companies include major drug companies Bristol-Myers Squibb (BMY), Merck (MRK) and Eli Lilly (LLY), as well as cigarette makers like Altria Group (MO) and Lorillard (LO). They yield anywhere from 4% to 7%.
PREFERRED STOCK: This market was hit in 2008 by multiple shocks, including the bankruptcy of preferred issuer Lehman Brothers, the banking industry's troubles and the government's surprise decision against protecting preferred shareholders of Fannie Mae and Freddie Mac, when Uncle Sam effectively seized those mortgage agencies. Fannie and Freddie preferred trade for about five cents on the dollar.

After bottoming in March, preferreds have surged, with most yields dropping to 6% to 9%. "Preferred stock is subject to the same inflation problem as bonds," Lieberman says. "But yields are significantly higher. That provides sufficient compensation...for the lack of inflation protection."

Citigroup's trust preferred securities, like its Series C, yield more than 9%. Bank of America's 7.25% Series J preferred trades around 21, for a yield of 8.60%, and Wells Fargo's 7.50% Series L preferred trades near 900 for an 8% yield. The Wells Fargo issue has a face value of $1,000, as opposed to $25 for most preferreds.

JPMorgan's preferred has lower yields, just under 7%, reflecting Wall Street's favorable view of the bank. Many foreign banks have issued preferreds; Lieberman likes Barclays, whose preferred yields about 8.5%. Among REITs, the largest preferred issuer is Public Storage, owner of self-storage facilities. Its preferred yields more than 7% and looks pretty safe, given the company's solid balance sheet.

There are two types of preferred. Regular preferred is a senior form of equity, while trust preferred is junior debt and is senior to regular preferred. Therefore it is safer, but it generally yields less. The advantage of regular preferred is that its payouts are taxed at the preferential dividend rate of 15%, while trust-preferred dividends are taxed as ordinary income.

CONVERTIBLE SECURITIES: These hybrid securities, which can be converted into common shares under preset conditions, were battered in 2008 by a weak stock market, the junk-bond market's collapse and forced sales by leveraged convertible hedge funds. But convertibles have risen sharply this year, with Putnam and Fidelity convertible mutual funds up 50% to 60%. The catalysts: the sharp rally in the shares of the generally more speculative companies that issue converts and the junk market's big gains..

This makes for slimmer picking than in early 2009, when investors could get 10% to 15% yields on reasonably solid converts. Be forewarned: It's tougher to buy converts than preferred stock because many convertible bonds are traded in an over-the-counter market where bid/offer spreads can be wide for individuals buying $25,000 to $100,000 of the securities. Convertible funds are a better bet for most investors.

For those willing to do their own work, converts can be an attractive lower-risk alternative to common stock, while offering much of common's appreciation potential.

The money-losing airline industry has needed to raise capital and their converts carry lower rates than regular debt. Issuers include USAirways Group, UAL (parent of United Airlines), Continental Airlines and JetBlue Airways.

Chip maker Micron Technology has a 1.875% issue trading around 85, yielding 5% with a hefty conversion premium of 50%.

One way to play Ford is via its Series S convertible preferred stock, which trades around 36. Ford stopped paying dividends on that issue this year, but some investors are betting the reviving auto maker may resume the payout in 2010 and give investors unpaid dividends of more than $1.50 a share. If Ford resumes the $3.25 annual dividend, the yield would be 9%. The car maker must pay the preferred dividend if it wants to resume a common dividend.

In sum, while hardly anything is as cheap or attractive as it was earlier this year, MLPs, utility stocks, preferred and converts offer appealing alternatives to increasingly unattractive bonds.

Dividend Stocks (Fortune Magazine)

Go the distance - Dividends for the long run
BY Scott Cendrowski,
Fortune — 11/09/09
Yield stocks always make sense. And even in tough times you can find companies with solid payouts.
(Fortune Magazine) -- This is shaping up as the worst year for dividend cuts in three generations. Striving to conserve cash amid the most severe slump since the Depression, companies are reducing or eliminating their payouts to shareholders.

Banks, of course, have led the way, but also cutting payouts are such stalwarts as Dow Chemical (DOW) (which hadn't cut its dividend since it began paying one in 1912!), General Electric (GE), and Pfizer (PFE ).

In all, 74 companies in the S&P 500 index have cut $48 billion in dividends in 2009 -- the highest amount ever -- and Standard & Poor's senior index analyst Howard Silverblatt forecasts average payouts to fall by 36% from last year. That would be the worst annual percentage decline since 1938.

But dividends are not dead. Some companies maintained or raised them in the past year, indicating that their payouts can survive even the worst markets. And dividend investing remains a sound course amid market turmoil. Ned Davis Research shows that since 1972, companies that increase or begin paying dividends have returned 9.5% a year, soundly beating the 6.8% return of the S&P 500.

So how do you find income stocks you can count on? Ideally you want established companies that have a long history of dividend increases.

You also want to look at the coverage ratio -- earnings per share divided by the dividend per share. A figure of two or higher tells you the company has plenty of money to pay its dividend. (Companies with lower coverage ratios can also be steady payers if they have stable cash flows.)

To help you identify reliable choices, we asked three top-rated fund managers who specialize in dividend stocks for their best ideas -- and did a little screening of our own.

We started with Rick Helm, manager of Cohen & Steers' Dividend Value fund (DVFAX ), which has outperformed its average competitor by 2.5 percentage points annually since its 2005 launch. Helm recommends Abbott Laboratories (ABT ), now yielding 3.1%. The $30 billion pharmaceutical giant, known for its rheumatoid arthritis drug Humira, has hiked its annual payouts for more than three decades.

Helm believes that no matter what happens with health-care reform, Abbott will thrive thanks to its diversified businesses in drugs, diagnostics, and nutritional drinks. He expects the stock, which trades at 14 times next year's estimated earnings, to appreciate smartly.

Roger Sit, chief investment officer of Sit Investment Associates, whose Dividend Growth fund (SDVSX ) has beaten the S&P by 4.9 percentage points a year since 2004, looks for companies with sustainable business models that dominate their industries.

For example, Verizon Communications (VZ), yielding 6.3%, is his top telecom holding. Sit notes that Verizon boasts the widest margins in wireless of any carrier and has almost completed building its FiOS high-speed Internet network, a massive project that cost $15 billion over five years.

Verizon's dividend coverage ratio is below one right now, but Sit analyst Joseph Eshoo considers Verizon's dividend to be safe and expects the coverage ratio to improve as spending on the FiOS network winds down. Eshoo prefers Verizon to rival AT&T (T ), which offers a similar yield, because of Verizon's superior mobile network.

Thomas Cameron, chairman of money-management firm Dividend Growth Advisors, has been preaching the value of dividends for 40 years. His Rising Dividend fund's (ICRDX) 3.7% annual return since 2004 has beaten the S&P 500 by nearly 3% a year.

Cameron likes Magellan Midstream Partners (MMP ), a $1.2 billion master limited partnership, or MLP, that runs more than 9,400 miles of oil pipeline in the U.S. He suggests buying MLPs such as Magellan, which offers a high yield and operates in the generally stable industry of energy infrastructure.

"They are never moving pipelines to China," he says. MLPs are set up to avoid corporate taxes. They must receive 90% of income from commodities, natural resources, interest, or dividends, and are required to pay out 100% of profits. Magellan pays $2.84 a share annually, for a 7.4% yield, which Cameron expects to grow in coming years as U.S. energy infrastructure is modernized.

Along with talking to fund managers, we examined S&P's list of stocks that have increased annual payouts for at least 10 years and have estimated coverage ratios of at least two for 2009 and 2010.

Of 69 companies making the cut, the top-yielder, at 4.3%, is Universal (UVV ), a Richmond-based tobacco grower with customers like giants Phillip Morris International and Japan Tobacco. With its largest customers selling cigarettes overseas, Universal is sheltered from U.S. legislation and declining smoking rates.

Also making the list was Johnson & Johnson (JNJ ), which we recommended last year as one of the best stocks to own in 2009. The pharmaceutical giant JNJ's 3.3% yield and 47 consecutive years of increasing dividends make the diverse manufacturer of everything from Band-Aids to Tylenol a strong pick in any environment.

Tax Advantaged HIgh Yield MLPs (from WSJ)

HEARD ON THE STREET OCTOBER 26, 2009
The Investments for These Taxing Times

By LIAM DENNING

Worried about a depreciating dollar, rising taxes and stingy investment yields?

Try Master Limited Partnerships. MLPs are listed partnerships that typically invest in hard assets like oil and natural-gas pipelines. They pay no corporate tax and offer investors high cash distributions, most of which is tax-deferred.
And their recent performance is hard to beat. Since the collapse of Lehman Brothers, the Alerian MLP Index has actually made a slight gain, compared with losses for the S&P 500 and the wider energy sector. This is even more impressive when you consider the MLP sector's Achilles' heel. MLPs paid out an average of 72% of their funds from operations after interest charges in the second quarter, according to CreditSights. That doesn't leave much money to invest in growth, leaving MLPs reliant on liquid capital markets -- precisely what was missing this past year.

The thaw in financial markets eases this pressure, as does the likelihood that the energy MLP sector's current capital expenditure cycle likely peaked last year.

All that previous infrastructure construction tees up future growth. Yves Siegel of Credit Suisse estimates the sector is currently yielding 7.8% and should boost distributions by 5% this year, offering juicy total returns in the range of 8%-12%.

The most attractive prospects are MLPs like Boardwalk Energy Partners that are heavily weighted to natural-gas transportation assets. These should benefit from long-term growth in demand for the fuel. And since their income is tied more to fees for pipeline capacity than throughput, they're insulated from the current weakness in natural-gas demand. With interest rates on the floor, you could do worse than seek refuge in a pipe.

Write to Liam Denning at liam.denning@wsj.com

Printed in The Wall Street Journal, page C8

Get Paid with Dividend Stocks (WSJ)

Shopping for Dividends in A Weak Market
By Ian Salisbury
A DOW JONES NEWSWIRES COLUMN
NEW YORK (Dow Jones)--It's been a rough year for dividends, but investors who want stocks with steady payouts may still be able to find them.

The financial crisis hit dividend investors particularly hard, in large part because financial stocks had long been their bread and butter. Overall, Standard & Poor's expects the total value of dividends paid by companies in the S&P 500 to fall to $191 billion in 2009 from $247 billion in 2008. Meanwhile, the prices of dividend-paying stocks have tumbled much more steeply than the rest of the market, posting average annual declines of 11% over the past three years, according to one benchmark.

Still, in some ways, the market's plunge highlights the importance of dividends, which in more normal circumstances can smooth market returns and help investors generate income. The more retirees can rely on regular payouts to cover living expenses, the fewer shares they'll have to sell each year to make ends meet.
"You don't want to have to sell shares at depressed prices at just the wrong time," says Reston, Va., financial adviser Mark Atherton. "Dividends help support a retirement distribution and reduce the chance you'll run out of money."

With stock prices still depressed, the average yield of dividend-paying stocks in the S&P 500 remains relatively high, about 2.6% compared to an average of 2% over the past 10 years. Investors do face the risk of a new wave of dividend cuts, especially with the economy being so slow to pull out of its recession.

"A lot of companies are paying dividends without making money," says Standard & Poor's analyst Howard Silverblatt. "They're putting their hands in their pockets."

One key will be watching what happens in the fourth quarter, says Silverblatt, since many corporations now in the midst of planning for next year will make their move then, if 2010 looks grim.

While the quest for dividends has gotten more difficult, fund managers say investors can still find attractive companies that make reliable payouts.

"If you look at the past few years, a lot of dividends reflected financial firms' profits in investment banking and mortgage underwriting," says Rick Helm, manager of Cohen & Steers Dividend Value Fund. As financial stock's share of the dividend stream has fallen - to about 10% of the whole from almost one third - he counts more on consumer staples stocks to generate income.

Among his holdings: Procter & Gamble Co. (PG), Altria Group Inc. (MO), and Wal-Mart Stores Inc. (WMT), a company Helm says weathers downturns better than other retailers, in part, because it sells so many groceries.

Another area not to overlook is master limited partnerships, according to Tom Cameron, co-portfolio manager of the Rising Dividend Growth Fund. MLPs, which invest in energy assets like natural gas pipelines, typically pass most of their profits out to investors, often translating into fat yields.

Energy Transfer Partners L.P. (ETP) and Magellan Midstream Partners L.P. (MMP), both in Cameron's portfolio, yield 8.6% and 7.9%, respectively, despite big run-ups so far this year. MLPs can have some tax advantages too, but investors should be aware they can be thinly traded with values tied to volatile energy prices.

(Ian Salisbury is a Getting Personal columnist who writes about personal finance; he covers topics including exchange-traded funds and separately managed accounts. He can be reached at 212-416-2241 or by email at ian.salisbury@dowjones.com.)

More on MLPs (from Barrons)

MONDAY, JULY 27, 2009
SPEAKING OF DIVIDENDS



Good Going, Partners
By SHIRLEY A. LAZO



MASTER LIMITED PARTNERSHIPS -- THE SUBJECT of a Barron's Follow-Up -- pass most of their profits along to their unitholders as tax-deferred distributions. MLPs typically invest in energy assets, and their units have taken a beating from the gyrations in oil prices. But they still make money, and four of them energized their dividends last week.

The Big-Board-listed quartet, which sport yields of 7% to 9%, are Sunoco Logistics (ticker: SXL), El Paso Pipeline (EPB), Holly Energy (HEP) and Western Gas (WES).

With 2008 revenue of more than $10 billion, Sunoco is by far the largest of the group. It was created by Sunoco (SUN), the big energy company, when it transferred most of its pipeline, terminal and storage assets to the partnership.

Despite lower crude-oil prices, which pushed second-quarter revenue down 61%, profits at Sunoco Logistics handily beat Wall Street's expectations. As a result, it declared a cash distribution for the second quarter of $1.04 per common partnership unit, 11.2% above the 2008 second quarter's payout and 2.5% over last quarter's $1.015. Yield: 7.42%. The distribution is payable Aug.14 to unitholders of record Aug. 7. The ex-dividend date is Aug. 5. Disbursements have been made since 2002, and this is the 24th increase in the past 25 quarters.

"Our strong second-quarter performance is a combination of stable cash flows in our base business, along with crude-oil-market opportunities resulting from a cantango [meaning futures prices are above spot prices] market structure," said Sunoco Logistics' CEO, Deborah M. Fretz. "Our conservative balance sheet and access to liquidity have us well positioned to further expand our business platform," she added.

Second-quarter net climbed to $66.6 million, or $1.74 per diluted limited-partner unit, 30% above the figure in the corresponding 2008 stretch. Revenue totaled $1.29 billion. Analysts, on average, had been expecting Sunoco to earn $1.49 on $1.17 billion.

The improvement came from more lease acquisitions, increased crude-oil pipeline and storage revenues, and benefits from the November acquisition of the MagTex refined-products pipeline and terminals system, plus significantly lower costs. Distributable cash flow in the quarter surged nearly 25% from the level a year earlier, to $71.8 million. Debt outstanding at June 30 came to $860.3 million.

The units set a 52-week high of 56.60 June 16. ValuEngine thinks that Sunoco "exhibits attractive volatility, momentum and risk" and therefore rates it a Strong Buy. Citigroup recently upgraded the MLP to Buy from Hold and raised its price target to 60. Sunoco's 52-week low is 27.62.


El Paso Pipeline sweetened its dividend to 33 cents per unit, for a 7% yield. That's an increase of 12% from the year-earlier distribution and 1.5% above the 32.5 cents paid in this year's first three months. El Paso has enriched its payout every quarter since its 2007 initial public offering.

The partnership, with 2008 revenue of $141 million, was formed by El Paso (EP) to own and operate natural-gas transportation pipelines and storage assets. The units currently trade around 19, and their 52-week range is 21.80 to 11.72. Goldman Sachs last week upgraded El Paso to its Conviction Buy list with a price target of 22, deeming recent weakness unjustified.

Holly Energy, which was formed by Holly Corp. (HOC) to acquire, own and operate refined-product pipeline and terminal facilities, added a penny to its payout, bringing it to 78.5 cents per unit, for a yield of 8.88%. Holly now has upped its distribution every quarter since becoming a public partnership in July 2004. The units change hands close to their 52-week high of 37.33; their 52-week low is 14.93. Goldman has downgraded Holly to Neutral, citing valuation.

Western Gas gathers, compresses, processes and transports natural gas for its parent, Anadarko Petroleum (APC), and others. It also raised its quarterly cash distribution a penny, to 31 cents per unit. Yielding 7.25%, its units hit a 52-week high of 17.15 Friday -- nearly double their 52-week low of 9.

Investing for Income: MLPs (WSJ)

JULY 18, 2009
Master Limited Partnerships Have Benefits, Risks
By KELLY GREENE

I am semiretired and have started to invest using a self-directed IRA. I also have started to invest in Master Limited Partnerships, mostly pipeline companies, within my IRA. The yields are very nice, and the share values appear to be increasing. It seems that MLPs are too good to be true. There must be a downside. Do you have any suggestions on the downside risks?

—Rick Herbold, Hingham, Mass.

Some financial planners are using, as the reader above is, master limited partnerships, or MLPs, to diversify retirees' portfolios, provide dividend income and try to hedge against inflation. And, yes, there are risks involved.

MLPs are typically limited partnerships that are publicly traded on a U.S. securities exchange. (You can invest in limited partnerships that aren't publicly traded, but the four experts we interviewed didn't recommend doing so.) As of last November, the U.S. MLP market was valued at more than $100 billion, according to a report by Standard & Poor's. You can read it online at www2.standardandpoors.com/spf/pdf/index/MLP_Primer_Nov2008.pdf.

Many MLPs are in the pipeline business, which may protect them somewhat from the energy industry's volatility. "You get paid for the volume going through the pipe, so the cost of the gas doesn't affect you," says Steven Stahler, a certified financial planner in Baton Rouge, La.

James Shelton, chief investment officer of Kanaly Trust Co. in Houston, started buying MLPs last fall. "The yields are still very attractive, and a lot of these MLPs are below highs they reached a year ago," he says.

Mr. Shelton favors three MLPs: Kinder Morgan Energy Partners LP, Enterprise Products Partners LP, and Plains All American Pipeline LP. "We're looking for these 9% stable yields where the dividend is going to grow over time."

Mr. Shelton says he avoids MLPs with "significant commodity-price risk in their business models."

As for the downsides, in throes of the credit crunch late last year, many MLPs fell in value amid fears that they could lose access to capital needed for expansion. So, if lending tightens further, MLPs could take a hit. What's more, if the economy worsens, "that theoretically could reduce the demand for the energy products [the projects] are transporting," Mr. Shelton says.

Also, some smaller MLPs are traded thinly. "When you need to move it, you're going to suffer a pretty significant decline," Mr. Shelton says.

When held in taxable accounts, MLPs provide some attractive tax advantages. Because of its structure, an MLP gets to pass its depreciation of assets and expenses through to investors, who may be able to use the pass-through expenses to reduce or eliminate the tax on the income received from that particular investment, Mr. Stahler says.
But you would lose that tax advantage by holding MLPs in a tax-deferred individual retirement account, and you have to pay ordinary income tax on any distributions you eventually take, says Ed Slott, an IRA consultant in Rockville Centre, N.Y.

And if an MLP investment generates what is known as "unrelated business taxable income," which is likely, the IRA has to file a separate tax return and pay any tax involved from assets in the account, Mr. Slott says.

There are two possible fixes.

First, you may want to consider converting your traditional IRA to a Roth so that you don't have to pay income tax on future earnings (subject to Roth holding rules). However, your account could still be subject to unrelated-business income tax, Mr. Slott says.

Another solution would be to make future investments in "closed-end" funds that invest in a number of publicly traded MLPs, says Mr. Stahler, who has used such funds for retired clients with large IRAs. Such funds aren't subject to the unrelated-business income tax, but still could benefit from potential returns. One example is Fiduciary/Claymore MLP Opportunity Fund, which was yielding more than 8% earlier this week.

Write to Kelly Greene at kelly.greene@wsj.com

Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved

Highest Yield (from Kiplinger Magazine)

Where to Find Top Yields
From safe municipal bonds to risky closed-end bond funds, just about everything is on sale.

By Jeffrey R. Kosnett

From Kiplinger's Personal Finance magazine, June 2009

It's been an excruciating year for income hogs, their favorite investments obliterated by the recession and the credit crunch. Since September, high-yielding standbys such as real estate investment trusts, master limited partnerships, business-development companies, and oil-and-gas royalty trusts have lost 50% or more. Junk bonds and emerging-markets debt have improved of late, but they've still sustained double-digit losses.
From calamity, however, springs opportunity. Many income securities are now tantalizingly cheap. Moreover, issuers of high-yielding stocks and bonds are sure to benefit from reflation -- the stimulation of global economies through massive government spending and rock-bottom interest rates. Reflation, which implies higher inflation, will hurt low-yielding Treasury bonds, but it should boost the profits of energy producers, real estate operators and highly leveraged companies that need to raise prices to prosper.


The bear market in most income investments has resulted in lower cash payouts, too. With virtually all segments of the real estate sector suffering, dozens of REITs have cut their distributions, and many are paying dividends mainly in stock. Energy trusts have trimmed their disbursements because of low prices for oil, natural gas and other products. Led by financials, hundreds of companies have cut or suspended dividends on their common stock this year.

Credit-market chaos wreaked havoc with the recommendations in our previous "yieldfest" (see Earn 8% or More, July 2008). Our best picks, emerging-markets bond funds such as Fidelity New Markets Income and Pimco Emerging Markets Bond, dropped about 10% over the past year through April 9. Pipeline stocks, such as Kinder Morgan Energy, also held up reasonably well. But we had our share of disasters. For example, First Industrial Realty Trust cratered by nearly 90%, while Genco Shipping & Trading dived 73%.

As the economy begins to improve, the rest of this year and 2010 will be much more rewarding for income seekers. From the safest to the riskiest, we offer our best bets for big cash returns over the coming year (of course, you should keep money that you'll need soon in supersafe instruments, such as money-market funds and bank accounts).

Municipal bonds
The recession is putting pressure on state and local coffers, so why feel good about the prospects for municipal debt? Munis, which rarely default, are yielding far more than comparable Treasury securities. This state of affairs is an anomaly because interest from munis is generally free of federal income taxes. And because munis offer such generous yields, they should hold up far better than Treasuries when the economy and inflation pick up. Still, to be on the safe side, we recommend avoiding tax-free bonds with maturities greater than ten years. At ten years, you can still find 4% to 4.5%, tax-free. That's the equivalent of 6% or so from a taxable bond. Ten-year Treasuries, by contrast, yielded 2.9% in mid April.

Like most other sectors of the bond market, munis suffered last year, but confidence in them has improved. Despite California's budget disaster, the state sold $6.5 billion of general-obligation bonds in March, the third-largest muni issue ever. These A-rated bonds have already gained value. In mid April, a California GO maturing in 2019 with a coupon of 5.5% sold at $1,050 for each $1,000 of face value to yield 4.7% to maturity. For a Californian in the top income-tax bracket, that's like getting 8% from a taxable bond. And for the highest earners living elsewhere, it's the equivalent of 7.2% from a taxable bond.

Some discount brokers, such as Fidelity and Charles Schwab, offer scores of good-quality tax-exempt bonds supported by taxes or the revenues from water bills, highway tolls and the like. In mid April, a representative ten-year, double-A-rated, noncallable water-system bond, such as an Orlando utilities commission issue, yielded 4.8% to maturity. If you prefer a fund, Baird Intermediate Muni (symbol BMBSX) was the top medium-maturity muni fund in both 2007 and 2008. Other standouts include Fidelity Intermediate Municipal Income (FLTMX), a member of the Kiplinger 25, and Schwab Tax-Free (SWNTX).

Ironclad mortgages
Toxic mortgages are the match that lit the financial firestorm, but you can't blame government-guaranteed loans from the Veterans Administration or the Federal Housing Administration. The VA foreclosure rate is 1.7%, compared with 13.7% for adjustable-rate subprime loans.

The best way to own these loans is through a Ginnie Mae fund. Backed by the full faith and credit of the federal government, the Government National Mortgage Association guarantees packages of FHA and VA debt bundled together by private lending institutions. From the perspective of timely repayment of principal and interest, Ginnie Maes are just as safe as Treasuries but deliver significantly more yield. And although mortgage rates have fallen, many GNMA funds still own lots of older, higher-paying loans. For example, almost 40% of the loans in Vanguard GNMA (VFIIX) carry yields of more than 6%.

Vanguard's fund and other low-cost Ginnie Mae funds, such as Payden GNMA (PYGNX) and Fidelity Ginnie Mae (FGMNX), still yield about 5%. GNMA yields should decline by half a percentage point by the end of 2009 because lower mortgage rates encourage more borrowers to refinance. But these securities will generate higher cash flows after mortgage rates, like other long-term rates, start to turn up later this year.

Bank-loan funds
These funds hold slices of adjustable-rate loans and lines of credit that banks extend to companies with junk credit ratings of single-B or double-B. Adviser Mark Gleason, of Wescap Management Group, in Burbank, Cal., aptly calls a bank-loan fund "a hybrid between a junk-bond fund and a money-market fund." The bank funds currently yield 4.5% to 6%, which is far short of junk's double-digit yields. But their loans are safer because their terms are short, their interest rates float with changes in short-term rates, and they are ahead of bonds on the repayment pecking order should the borrower default. However, like stocks and junk bonds, bank loans gain value prior to or in the early stages of an economic recovery. Year-to-date through April 9, bank-loan funds returned an average of 11.1%, tops among bond-fund categories.

By contrast, in the three-month period that ended last November, the average bank-loan fund lost 29% as the credit crunch and selling by hedge funds slashed the value of bank debt. But defaults didn't get out of hand, so funds such as Fidelity Floating-Rate High Income (FFRHX) and the closed-end PIMCO Floating Rate Strategy (PFN) kept up decent monthly distributions even as their share prices dropped. These payouts are sliding because short-term interest rates are near zero, but bank-loan funds still offer better yields than short-term-bond funds. Gleason sees annual total returns of 9% to 11% through 2012.

Triple-B corporate bonds
This is the sweet spot in taxable bonds. In 2008, the gap between yields of a basket of triple-B-rated bonds and Treasuries exploded from two percentage points to six and a half. In mid April, the gap was almost five points, which is attractive when you consider that bonds rated triple-B are still considered investment-grade. Moreover, the category harbors a bunch of recession-hit companies that traditionally have carried single-A ratings. Today's triple-B roster includes Altria, Burlington Northern, Johnson Controls, Kraft Foods, Black & Decker, Sunoco and XTO Energy. All will thrive in better times.

For safety's sake, choose bonds from across several industries. Noncallable bonds are nice, but as rates rise, you won't see many redeemed early anyway. In mid April, an Altria bond maturing in 2018 and carrying a 9.7% interest coupon was priced to yield 8% to maturity. Bank and insurance bonds offer high yields because financial issuers are riskier than industrials, despite government efforts to keep them afloat without nationalizing them.

Pipelines
Energy prices will rise as industry expands and people drive more. So you can buy energy-income investments at sale prices and hold on for what should be higher future dividends. If you think oil prices will zoom or if you just want to hedge against inflation, buy BP Prudhoe Bay (BPT), a royalty trust that passes through cash from the sale of crude oil. BPT crashed last summer and has cut dividends two times since, but it's back to $68 from a low of $50, and it yields 6%.



If you don't want to gamble on energy prices, pipelines and storage facilities are the ticket. Their dividends depend on the amount, not the price, of the products that move through these systems. Energy Transfer Partners (ETP), Kinder Morgan Energy Partners (KMP) and Magellan Midstream Partners (MMP) all have long histories of delivering dividends reliably, and they currently yield from 8.8% to 9.2%. Because these firms are set up as master limited partnerships, they'll send you a Form K-1 at tax time, rather than a Form 1099, and that could mean extra work filling out your returns.

Preferred stocks
It wasn't just common stocks that went on a tear after bottoming on March 9. Preferred stocks, which act a lot more like bonds than stocks, also rallied strongly. From March 9 through April 9, iShares U.S. Preferred Stock Index (PFF), an exchange-traded fund, rocketed 66%, although it remains 45% below its 12-month high. Tom Taylor, of Thoma Capital Management, in Towson, Md., notes that a preferred stock from Bank of America (BAC.H) yields 14% to maturity in 2013 and cannot be called or exchanged. The stock surged from $5 to $15 between February 19 and April 9. But its face value is $25, so it can still go higher.

Preferreds, despite the reassuring name, are not risk-free. Issuers can cut or suspend preferred dividends, as a handful of REITs have done during the financial crisis. And if a company files for bankruptcy, bondholders take precedence over preferred investors. You can spread your risk with a fund that focuses on preferreds. John Hancock Preferred Income (HPI), a closed-end fund, owns far fewer financials than does the iShares ETF. At its April 9 close of $12, the fund traded at a 4% premium to its net asset value and yielded 15%. It would be better if the fund traded at a discount to NAV, but the modest premium is acceptable.

Junk corporate bonds
Let's face it: Recessions are not good for junk bonds and their issuers. Junk-rated companies are young, troubled, highly leveraged, or some combination of the three. So it's not surprising that they suffer when sales sink and questions about their ability to service their debt mount.

But the current recession has been less discriminating than most. Previous junk-bond routs involved "bad companies with bad balance sheets," says Mark Durbiano, a manager at Federated Investors who has seen the good, the bad and the ugly during a 25-year career investing in high-yield bonds. This time, he says, investors pummeled bonds of essentially good companies, such as First Data and SunGard, whose high debt loads earn them junk ratings. The average junk bond recently yielded 18%, a near-record 15 percentage points more than Treasury bonds.

But now, with signs that the economy is thawing and bargain hunters nibbling, things are starting to look up. The average junk-bond fund, which lost 26% last year, returned 6% in 2009 through April 9. The indexes -- but not the whole sector -- will take a temporary hit if General Motors, a huge junk-bond issuer, defaults. But the three primary junk ETFs -- SPDR Barclays Capital (JNK), iShares iBoxx $ High Yield (HYG) and PowerShares High Yield (PHB) -- hold few or no GM bonds (but plenty of health and technology issues). Each yields 10% or higher.

Wild closed-ends
We've saved our lottery tickets for last. Scott Leonard, of Trovena, an advisory firm in Redondo Beach, Cal., seeks out income-oriented closed-end funds in struggling but improving sectors that are leveraged, selling at big discounts to NAV. Dozens qualify. Consider, for example, Cohen & Steers REIT and Utility Income (RTU). At its April 9 close of $5.28, the fund sold at a whopping 25% discount to NAV and yielded a similarly massive 26%. Or look at BlackRock California Municipal Income Trust II (BCL). At a price of $10.18, it traded at a 19% discount to NAV and yielded 6% tax-free. Don't put more than 5% of your income assets into these kinds of funds because when they're bad, they're really, really bad.



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Your Retirement Paycheck: Model Portfolios from Kiplingers Magazine

Investments That Pay You Every Month
These three portfolios should produce reliable yields of 5% to almost 10%.

By Jeffrey R. Kosnett

May 4, 2009

In the summer of 2008, I devised three portfolios composed entirely of investments that pay dividends or interest every month. These portfolios are ideal for people who need spending money, as opposed to those who invest in bonds, real estate investment trusts or other kinds of income-oriented vehicles for diversification. The yields on these portfolios ranged from 6% for a mix of moderate-risk bond funds and high-dividend stock funds to more than 10% for a riskier collection of energy royalty trusts, leveraged bank-loan funds and foreign-currency bond funds.



For the most part, the dividends have held up -- the notable exceptions being the oil-and-gas pass-through investments and the bank stocks. But the principal has fallen far more than I imagined even remotely possible. By the time the stock market bottomed in March, share prices for a package of energy income trusts, bank-loan funds and REITs were, on average, half of what they were in mid 2008. If you had started the aggressive, high-income portfolio in June or July of 2008, you were probably down 30% or so on a total-return basis.

Not surprisingly, the lowest-risk portfolio did considerably better, although it, too, was in the red. That package had one-fourth invested in energy and other high-wire stuff, one-fourth in a high-dividend, exchange-traded stock fund, and the rest in Vanguard Total Bond Market Index. The portfolio generated about 8% in income and lost about 20% of its market value -- lousy but, all things considered, tolerable.

Assembling a ladder of Treasury bonds over the past year would have produced a small capital gain, but it would have left you far short of needed income. And that's still true today. You can't build a high-income portfolio -- whether it pays monthly or less frequently -- without taking some risk with your principal.

The good news is that all of these high-risk categories are past the worst. Junk bonds and bank-loan funds have been recovering handsomely in 2009. Ditto for REITs. Payouts -- and share prices -- of oil-and-gas trusts remain depressed, but energy prices and cash disbursements will rise as the world economy improves.

Still, the fact that such formerly trouble-free investments as Enerplus Resources Fund (symbol ERF), a trust that owns a diversified package of energy-producing properties in North America, and Eaton Vance Senior Floating-Rate Trust (EFR), a closed-end bank-loan fund, could lose more than 50% in less than a year is troubling. Many reputable financial advisers and I believed that investments that paid a steady stream of income would be fairly stable. That perception is another casualty of the financial crisis.

So it's time for a new, post-collapse edition of the Cash In Hand Monthly Income Plan. You may have less principal now, but the principle remains the same. You choose from among three approaches: Shoot for maximum yield of 9% to 10%; go conservative and pick up about 5%; or take a middle-of-the-road course. The growing number of bond ETFs (see Welcome Additions: More Bond ETFs), which make monthly distributions, provides some fresh choices. Only a few open-end bond funds, REITs and energy pass-throughs pay 12 times a year (although virtually all Vanguard bond funds pay monthly).

High-risk, high-yield plan
Estimated yield: 9.5%

35%, energy trusts. Energy is still the leading category to hunt for high current income. The typical royalty trust or master limited partnership is priced to yield about 10%. Choose at least three out of a group that includes names such as Cross Timbers Royalty Trust (CRT), Enerplus, Penn West Energy Trust (PWE) and Provident Energy Trust (PVX). All are fairly diversified. Avoid trusts that sell only natural gas. Gas should be a good long-term investment, but there's a surplus of it now and its price will stay depressed longer than oil's price will.

20%, bank-loan funds. The best no-load, open-end fund in this category is Fidelity Floating Rate High Income Fund (FFRHX). Among leveraged, closed-end funds, two possible choices are BlackRock Floating Rate Income Strategies Fund (FRA) and BlackRock Floating Rate Income Strategies II (FRB). In early May, both sported high yields, and their share prices traded at discounts to the value of their underlying assets (that's a must if you invest in a leveraged closed-end). Two parts Fido to one part BlackRock sounds like a good recipe.

15%, corporate junk bonds. Vanguard's low-cost, no-load offering, Vanguard High-Yield Corporate (VWEHX), is the first choice here. Loomis Sayles Bond Fund (LSBRX) is really more of a go-anywhere fund, but it usually holds a substantial amount of its assets in junk bonds and emerging-markets bonds, as well as investment-grade corporates. The fund, a member of the Kiplinger 25, yields about 9.7% and complements the Vanguard fund well.

15%, real estate. The anchor of every check-a-month plan should be Realty Income (O). This is a high-quality, one-of-a-kind REIT that calls itself the Monthly Dividend Company. It owns more than 2,000 properties leased to well-known retailers and restaurant chains. Realty Income has paid 463 consecutive monthly dividends. Not every streak is solid these days, but this one is as close as you can get to a sure thing. Plus, the share price fell far less than that of most REITs during the market's downturn. Realty Income yielded 8% in early May.

10%, preferred stocks. The PowerShares Preferred Portfolio (PGX) is an unleveraged ETF that passes through dividends from an array of preferred bank and utility stocks. It has stabilized after losing half its value from May 2008 to February 2009.

5%, emerging-markets bonds. Two ETFs, iShares JPMorgan U.S. Dollar Emerging Markets Bond (EMB) and PowerShares Emerging Markets Sovereign Debt (PCY), invest in bonds from such places as Russia, Brazil, Turkey, Indonesia and Mexico. After running into trouble in the fall of 2008, the funds, both of which pay monthly, have rebounded handsomely.

The centrist plan
Estimated yield: 8%.

Choose among the same funds, trusts and ETFs as above, but tweak the allocation to make room for a chunk of investment-grade corporate bonds. You could split the high-grade bond exposure between Loomis Sayles Bond and an ETF such as iShares iBoxx Investment Grade Corporate Bond Fund (LQD). The mix:

20%, energy trusts.

20%, investment-grade corporate bonds.

15%, bank-loan funds.

15%, Realty Income.

15%, corporate junk bonds.

10%, emerging-markets bonds.

5%, Vanguard GNMA (VFIIX). The soundest mortgage-related investment around, this Vanguard fund invests in securities backed by the full faith and credit of the U.S. government.

The conservative plan
Estimated yield: 5.5%.

The conservative plan emphasizes the entire range of bonds, including Treasuries (which can't go bust but yield next to nothing and will almost surely lose value if inflation accelerates and if interest rates rise). Then we add some other safe, high-yield categories for balance.

60%, diversified, high-quality bonds. Pick either Vanguard Total Bond Market Index (VBMFX) or its ETF sibling, Vanguard Total Bond Market ETF (BND). You'll get paid about the same each month; the main disadvantage of the ETF is that you incur commissions every time you buy or sell.

10%, energy trusts.

10%, Realty Income.

10%, bank-loan funds.

10%, Vanguard GNMA.


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