“Bonded Trusts — Bailout Loophole Creates Massive Windfall”

By Travis Johnson, Stock Gumshoe, October 20, 2008

Today’s investment teaser ad comes to us from the fine folks at Stansberry & Associates — this time it’s from Tom Dyson, for his 12% Letter … which, as you might imagine, is aimed at dividend income.

And it is, at least, more honestly named than the “25% Cash Machine” that another publishing house offers for similar types of investments.

We’ve looked at a number of Dyson’s picks over the years, and he often comes up with interesting ones, nearly always with above-average dividend yields … with, of course, an interesting little story to go along with them. Numbers don’t always sell subscriptions, after all, but a good copywriter can make almost anything sound sexy.

And in this market, I suppose, you needn’t go far to make a little steady income from dividends sound sexy — now that we’re all terrified of growth and high PEs and bank stocks … and in some cases, I’m sure, wondering whether you can use a Starbucks coffee bag to bury your cash in the backyard, or does it really have to be a can?

Today, Dyson spins the tale by inventing a term for this investment: Bonded Trusts.

Sound familiar? Well, yes, it does sound kind of familiar — but not because it’s used in investing circles, more because it sounds like the kind of thing lawyers probably talk about … and because, in the back of your brain, you’re probably thinking that the Wall Street fat cats have been making money off of something sneaky like this that you’ve never really heard of. And you want in. Especially if it includes the words “bond” and “trust,” both of which sound a bit more promising than “stocks” at the moment.

But no, rest assured, there are no real secrets in this “bonded trust” world — or at least, not in the investments that Dyson is teasing with that phrase today. And if there are secrets, well, the Gumshoe is on the case, so they needn’t remain secret for long.

Let’s dig in a bit, shall we?

The spin, as it so often is these days, is about the bailout/rescue plan, and about a way that you can get your own bailout.

Here’s the pitch:

“You see, this Wall Street-Washington slumber party has created a once-in-a-lifetime opportunity for folks like you and me as well…

A loophole you can exploit to re-claim nearly all of that $700 billion.

I’m talking about a unique kind of investment, written into the tax code, specifically designed to pay out regular cash distributions – every four weeks – far into the foreseeable future…

All subsidized in a very big way by the government’s so-called “plan.” And all required by law to make these payments.

With the rest of the market in free-fall, it might surprise you that such an opportunity is possible. You might even find it hard to believe. And I don’t blame you.

As MSN Money reports: If you’ve never heard of this unique investment, ‘join the club… this little cash cow [has gotten] lost in the shuffle.’

Even The Wall Street Journal says ‘they look too good to be true’…”

So … are you excited about finding your loophole?

Well, I can blow off a little of that head of steam for you as we get started — Dyson here is talking not about anything new and sexy, or really about anything that’s all that particularly related to the banking sector or the financial rescue plan(s).

He’s talking about Master Limited Partnerships (MLPs)

Sound familiar? Yes, these investments are favored by several of the big newsletter publishers these days, and by many pundits as well. Heck, even Jim Cramer got on board a few of them in his recent conversion to dividend-loving depressive (on the downswing from growth-loving manic).

I’ve even written about them a few times recently — I think the last one was just a week or two ago, when I wrote about Graham Summers and his “Reagan Stimulus Dividends” that he called the “greatest income investments of all time.”

Tom Dyson has written about these many times in the past too, of course, and his colleagues at Stansberry have made the rounds, too, particularly with what they called the American Oil Pension over a year and a half ago.

And they’re fine investments — I don’t like to give too much opinion in this space, since it implies that I know more than others … I probably don’t, and my portfolio has been clobbered at least as badly as most of yours, I assume. But it’s hard to argue with the fact that pipeline MLPs are a ridiculously good buy right now. Not as absurdly good as they were a couple weeks ago when absolutely everything was being sold, no matter what, but no one ever should count on catching the “bottom” and they’re certainly worth looking at for many investors.

As with most teases of this type, Dyson also tells us that he’s picked out the best portfolio of these stocks for you, and he teases us with a few of the details of one of those stocks. Well, I guess you’d call them “units” in this case, since they’re partnership shares and not common equity. Still, they trade exactly the same way as stocks, albeit with somewhat more complex tax implications, so I will probably keep calling them “stocks.”

Anyway, here’s how he teases us about one of these investments:

“One Bonded Trust I want to tell you about today is issued by one of the largest oil and natural gas distributors in the country. This company owns a vast network of pipelines, storage facilities and processing plants throughout the US.

“Again, hard assets.

“The company was founded in 1992 and made its first quarterly cash payout in October of that year. Since then, it has never missed a single payout. In fact, its payouts have increased 35 times.”

Now, you may have noticed a certain lack of clues floating around in those paragraphs — I noticed that, too. So the Thinkolator had to chug quite a bit in coming up with a solution, and it’s not possible to be 100% certain without doing a lot more work, but I’m fairly sure now that this is …

Kinder Morgan Energy Partners (KMP)

Kinder Morgan is the Big Daddy of MLPs — the general partner, Kinder Morgan, Inc., used to be publicly traded, too, but isn’t anymore (it’s now a private company called Knight), but they still have two pipeline partnerships that trade publicly, and KMP is the bigger and older one. If you’re unfamiliar with the terms, the general partner is the firm that runs the pipelines and gets a management fee, and sometimes a sweetened regular payout, and the limited partners are the shareholders/unitholders like you and I, who are part owners but don’t do any work and collect a monthly or quarterly dividend.

KMP has indeed raised it’s payout roughly 35 times since they were launched in 1992, and they did pay their first dividend in October of that year.

And if you’re looking to build a portfolio of MLPs, Kinder Morgan is certainly one of the big ones that you should look at — there are dozens of these companies, but only a few that are of comparable size, and if you’re an individual investor and can only buy a few of these it’s comforting to buy those that don’t depend on a single property or pipeline.

That stability and size come at a price — KMP yields slightly less than some of its competitors, though the current dividend yield is just a hair under 8% so it’s hard to complain. Some of the other big MLPs, like Enterprise Product Partners (EPD) or Boardwalk Pipeline Partners (BWP) yield closer to 9% or even a bit more, though not many still have the 10-11% yields that we saw two weeks ago. A Barron’s article last week quoted Seth Glickenhaus as recommending those two plus Energy Transfer Partners (ETP), and OneOk (OKS) and El Paso Pipeline (EPB) were also noted as picks from other analysts. It’s hard to argue against that list as a good starting point for investigation — see the MLP listings at QuantumOnline.com if you’d like more tickers to research. That same Barron’s article quoted Citibank as seeing a huge move ahead for pipeline MLPs in the next year, with 63% returns possible for the group.

They’ve already gotten 10-20% returns from those v-shaped lows of a couple weeks ago, and I have no idea whether they’ll take another hit in the near future, but you could probably do much worse than look into a basket of MLPs if you value stability and income.

And I should also note that there are two exchange traded baskets for MLPs — there’s an ETN from Bearlinx with the ticker BSR, and there are some closed end funds that might be worth a look. Several Tortoise Capital Advisors MLP funds are available, and there’s another one called the MLP and Strategic Equity Fund (ticker MTP). Both of those have some hair on them and neither is an ETF — the ETN is a note, not a fund, so it’s guaranteed by Bear Stearns (now J.P. Morgan, I assume), not by any underlying assets, and the MTP fund bets on future market moves with forward contracts to try to boost returns. It also trades at a premium at the moment, which is currently quite unusual for closed end funds. Any one of those funds might be worth looking at if you’re not one of those who likes dealing with K-1 tax forms or the recordkeeping required of MLP holders (as I wrote in the Reagan article linked in the next paragraph, MLPs started as tax shelters and are still tax-advantaged, largely because you can defer some taxes until you sell your shares, but there is extra recordkeeping and tax form work required).

If you’re interested in reading up more on MLPs, I shared some additional comments when I wrote about the Reagan Stimulus Dividends a little while back.

And if you want to know a bit more about the sector, here’s a little more of Tom Dyson’s sell language:

“The beauty of these assets is that they’re virtually risk-free… for two very important reasons:

“1. Once built, there’s nothing else to do. You just sit back and collect the cash.

“Take an oil pipeline, for example…

“After you’ve built the pipeline, the revenue is almost all income. It doesn’t matter what’s happening on Wall Street or Capitol Hill.

“Your pipeline will never go away. And it’ll crank out dividends for the next 100 years.

“2. Once built, it’s virtually impossible for another company to come in and steal that business. They’re virtual monopolies.

“Think about it: It makes no sense to build a pipeline right next to one that already exists. It makes no sense to build a railroad line between two cities when there already is one.

“That makes Bonded Trusts not only “cash cows,” as MSN says… but also, perhaps, the safest place you can put your money in the entire world. “

Again, that’s a pretty solid bull case for MLP investing, especially in those partnership that own long-lived fixed assets (as opposed to the many other kinds of riskier MLPs out there, from asset managers to oil and gas explorers).

There is, of course, a bear case, too. There is no guarantee that MLP yields will be able to keep up with inflation, or that any individual MLP won’t have serious problems that require big capital investment and/or big lawsuit settlements for leaks or spills. And most of them carry quite a bit of debt — normally that’s not a big deal, because it’s easy to borrow money for income-producing, long lived assets. But “normal” isn’t necessarily normal anymore. And I suppose we should remember that any company, whether it’s an MLP or a regular public company, can crash and burn — a nice little reminder of that is the fact that Kinder Morgan’s pipeline partnership was actually born from the ashes of Enron, which had a pipeline business under their umbrella.

Much of the weakness in the share price of MLPs this year has come along with both the fall in the market when investors sold everything — and many MLPs are predominantly owned by individual investors — but it has also come from the falling prices of oil and gas.

In theory, the price of natural gas shouldn’t impact a pipeline company — they charge a toll, often a regulated toll set in long term contracts, for transporting the gas, they don’t typically buy or sell much of the stuff themselves. But in practice, the shares often fall alongside falling energy prices, regardless of how irrational that might be in any individual case.

There is a kernel of genuine worry if you believe that oil and gas prices will be long-term decliners, down to historic lows: oil and gas companies will be less pliable, and less likely to sign long term contracts at higher rates for pipeline access, if they’re unable to make a profit. They may try to squeeze their contractors, and pipelines are one of those contracts. The supply and demand of pipeline access to and from various areas of the country should be the main driver of their long term health and profitability, but certainly that dynamic is not completely independent of the price of the commodity they’re transporting.

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26 Comments on "“Bonded Trusts — Bailout Loophole Creates Massive Windfall”"

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bruce
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bruce
October 20, 2008 10:59 am

I like Calumet symbol CLMT, bought some at like 13, more at 9, now it seems to be recovering. It seems to me that with crude weakening, that specialty refiners should do well. Good dividend yield on this one as well, however chasing yields can be dangerous – buy a yield only if the company is sound. Also, CLMT had some large insider buying a few months back.

Bruce
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October 20, 2008 11:03 am

My wife and I hold stock in KMP. [We also held some BWP and EPD, but we sold those off to concentrate on KMP. Our tax preparer charges extra for processing the MLPs.] KMP has been good to us. The runup a couple of years ago wasn’t as great as some other energy stocks, but the recent dive hasn’t been as bad. And those distributions are music to my ears (and bank account).

Bruce

MKoss
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MKoss
October 20, 2008 12:27 pm

Hey Gumshoe,

I know these MLPs quite well. Just a correction KMP was not born out of the wreckage of Enron. Richard Kinder did not like where Enron was heading and left sometime between 1996 and 1998 and he bought the pipeline assets from Enron who no longer felt they were worth their time

destry
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destry
October 20, 2008 1:06 pm

Kayne Anderson closed-ends offer (kye), and (kyn)
Kinder Morgan is 14% or so of each…Nice dividends.

Skip
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Skip
October 20, 2008 8:30 pm

An issue with mlp’s is the form K thing that may arrive late and are complex enough that some cpa’s charge extra to complete as was mentioned. With respect to KMP, I read somewhere that KMR is similar but doesn’t generate a schedule K.

Dusty
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Dusty
October 20, 2008 11:46 pm
I got unhappy with my CPA. Met him once a year, nice guy, nice conversation but never could get to the nitty gritty of the current situation of the taxes which changed dramatically for me every year. Will probably never know if there were mistakes or misdirection in all that. Gave up and started doing my taxes myself. Not that hard. Follow the step-by-step; do not try to anticipate where it is going. It is facinating what there is to learn about tax structure. I have Canadian Trusts, MLP’s, US stocks with and without dividends, profits and losses, other income.… Read more »
Tom Healy CPA
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Tom Healy CPA
October 21, 2008 1:45 am

I tell clients that they should get enough of an MLP so after the extra cost to include the K-1 info on their returns the yield is still good. And don’t trade in-and-out frequently. The killer for extra time is when you sell units. I have quite a few of them in my own portfolio, and added to them in the recent crash.

JoeMurphy
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JoeMurphy
October 21, 2008 7:39 pm
MLPs can be a problem if held in an IRA. Some but not all generate something called UBIT. More than $1000 means taxes are due, which your broker is going to have to take care of. Both KYN and its cousin TYG are CEFs which issue 1099s instead of K-1s, so no IRA problem. Both KMR and EEQ are the management arms of their respective pipeline companies (KMP and EEP), and they issue shares (sort of a mini-split) equal in value to the dividends paid by KMP and EEQ. No K-1, no 1099, and no taxes due until you sell… Read more »
Al
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Al
October 22, 2008 9:23 am

I’m new to the investment world and interested in investing. Read some info ref Bonded Trusts and KMP is pretty the headliner. how do I get started?

Laura
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Laura
November 3, 2008 8:29 am

Thanks for this. I got that newsletter today and was more than a little skeptical. I googled bonded trusts and found your site. I really appreciate the clarification!

Cliff Parker
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Cliff Parker
November 22, 2008 2:49 pm
I was laid off last month, 401k down 36%, kids still in college and have a house w/mortgage that I can’t sell in this market. Looking for someplace to invest what I have left after I set aside the necessary (who knows what the escalation factor should be) cash to cover future bills, living expenses and COBRA health insurance premiums. So as it is always tempting to bite @ the flurry of “secret deals” offered to me every day in my inbox, it is even better to have access to the invaluable information provided by the “stock gumshoe” and the… Read more »
Maryanne Huang
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Maryanne Huang
November 22, 2008 5:44 pm

This got to be the topper for an exotic title to draw you in! Was disappointed when it turned out to be nothing new and nothing to do with the bialout (I have KMP MMP APL and when transport gas over water, TGP) but 12% newsletter has other good information and ideas and its only $49/year. Keep up the good work!

Rodney Stokes
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0
November 29, 2008 4:52 am

Hi – can anyone please advise me? I am a UK citizen living in the UK, can anyone living outside the US and not being a US citizen invest in
MLP’s?

Lynn Horng
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0
November 30, 2008 8:28 am

Hi,
I was interested in MLP’s until I read somewhere that you, the investor, have unlimited liability for the company’s debts. If the company goes under your personal assets can be targeted. If this is true (is it?) why wasn’t this mentioned on your site? I assumed it was true and was very disappointed, and decided not to invest. I would be thrilled if it weren’t true.

Dave
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Dave
December 24, 2008 5:16 am
I am keen to invest in the stock market etc., but, as a non US citizen currently residing in a non tax paying jurisdiction, how safe is it to use an on line brokerage? With companies going bankrupt regularly, How can one have faith in on line brokers in current market conditions? Passwords and codes can easily be hacked and as such cannot possibly be secure. Depositing relatively large sums of money (for me at least) with an entity with limited liability whose creation was established only a few years ago appears extremely risky. They have not been in existence… Read more »
Jim
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0
December 31, 2008 4:12 pm

I Still Don’t Know or Understand , What a Bonded Trust is ? To anyone That Knows , Please Give Some Examples of Bonded Trusts . . . Ticker Symbols , Risk , Min’s , Etc. . . .

Jim
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0
January 3, 2009 2:03 pm

So No One Else No’s Eighter ?

Gravity Switch
Admin
11
October 20, 2008 1:24 pm

You’re right, sorry — that’s definitely an exaggeration on my part. KMP’s predecessor was Enron Liquids Pipeline — that’s the one that started in 1992, and Kinder and Morgan bought it in 1997, when Enron was still hot stuff (in a good way — the real collapse was still a couple years off).

So … not born of the wreckage, perhaps it’s fairer to say they got out of the car just before the accident.

Gravity Switch
Admin
11
October 20, 2008 1:24 pm

Didn’t know those, thanks.

Fred
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Fred
October 20, 2008 11:27 pm

Another problem is the recapture of all of the tax benefits when you sell. After a few years these recaptures can be 25% or more and are taxed at ordinary income rates, not dividend rates

Dan
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Dan
October 22, 2008 10:36 am

Bruce

My wife and I got involved in a limited partnership in the late 90’s. We do our own taxes and the tax forms were a nightmare, especially since state forms were required. You mention of your tax guy charging you more to do your taxes because of KMP. Do you know if it is still as bad as it was 10 years ago? I thought that since the stock traded on the exchange that it would be treated like any other stock tax-wise.

Thanks

Bobby Cook
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Bobby Cook
October 25, 2008 11:00 am

For a solid place to go for info, check out investopedia.com and another site for dividend info check out dividendinvestor.com..

Between thsse 2 you should be able to get a good start..Rememvder to your home work on the fundamentals…

Alan
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Alan
November 8, 2008 1:25 am

Joe,
Can you tell me what a UBIT is?? Also what are CEF’s?? Both my wife and I are retired and each have individual IRA’s that to this point we have not had to rely on for an income. I’m just starting research this Master Limited Partner- ship idea (opportunity??) and it appears there may be some drawbacks. Would appreciate any comment you may have.

Alan

Gravity Switch
Admin
11
November 8, 2008 9:52 am
CEFs are closed-end funds, mutual funds that have a set number of shares and trade on an exchange, usually at either a discount or premium to the actual value of their holdings. UBIT is Unrelated Business Income Tax — as I understand it, if you have over a certain amount of income from MLPs or similar vehicles in your IRA, you’ll be obligated to pay tax on that income even though it’s a tax-sheltered account. MLPs are being touted by almost all the newsletter families now — there are drawbacks, as with everything, but there’s something to be said for… Read more »
Gravity Switch
Admin
11
November 30, 2008 8:46 am
Lynn, I’m not a lawyer, so please don’t count on just my response. But my understanding is that General Partners have unlimited liability, but “Limited Partners” (which is what you’re buying, a share of a limited partnership) means that the liability is limited. General partners are the ones who actually manage the partnership, and sometimes GP companies are also publicly traded, but MLPs themselves are limited. That doesn’t mean there isn’t any liability — there are potential liabilities for taxes, and I think there is the potential that some distributions could be called back if the partnership is liable for… Read more »
Gravity Switch
Admin
11
January 3, 2009 9:24 pm
“Bonded Trusts” are master limited partnerships, the ones that are typically touted are the ones that own energy infrastructure assets, particularly storage facilities and pipelines. A few dozen are large and publicly traded, one easy place to see a list of them with basic information is QuantumOnline.com (you have to register, but it’s free). Some of the better known ones are Kinder Morgan, Boardwalk Pipeline Partners (I own those two), Enterprise Product partners, Oneok, and there are many more that don’t come instantly to mind. Risk profile differs for all of them, but the ones that primarily own pipelines depend… Read more »
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