Siphoning: “Legally ‘Trick’ a Mutual Fund into Paying for Your Retirement”

By Travis Johnson, Stock Gumshoe, June 14, 2010

There’s something just lovely about the humble quotation mark — throw a couple of ’em around a word, and you can put that word wherever you want and apparently face no consequences.

This ad is for the Safe Haven Investor newsletter from Taipan, which is now edited by Kent Lucas, and, as usual, it’s pretty far over the top … here’s the start of the ad:

“How to Legally ‘Trick’ a Mutual Fund Into Paying for Your Retirement

“This little-known “siphoning” method can pay 10 times more than the best mutual funds — without charging you any inflated fees. That’s probably why you’ve never heard of it before.

“Follow the instructions in this letter and you can ‘siphon’ your first payment as soon as July 31.

“‘Worried about a depreciating dollar, rising taxes and stingy investment yields? Try [“siphoning”].’ — Wall Street Journal”

So how do we “trick” a mutual fund into doing this? Well, as you might have guessed … this strategy has almost nothing at all to do with mutual funds, but that “almost” and the quotation marks apparently go a long way. It’s about a high-yielding asset class, let’s look at some more of their pitch.

“The wealthy love using it to generate steady, risk-free monthly income. But this perfectly legal method can be used by investors of any income level to collect large checks, every month of the year, hassle-free.

“I call it ‘siphoning’ because it takes a portion of income from some of the biggest mutual funds in the country… and ‘siphons’ it directly to you.

“Instead of paying some hotshot fund manager outrageous fees, you’re actually getting mutual funds and other institutional investors to pay you.”

Ah, so because you’re not paying a management fee it’s like you’re “siphoning” some of your own money back into your pocket? Hmmmm.

So what is this investment? Well, they say in the ad that you could have gotten 123% returns from this investment in the past two years, so that sounds lovely. And you get monthly checks, which I know many folks just adore.

Here’s some more of the convolution:

“Here’s how the process works: After you sign up, you’ll have to designate whether you want the profits mailed to you, deposited directly to your bank account, or reinvested into the process to make your payments larger and larger every month.

“Then, on the designated ‘pay day’ every month, you’ll receive your ‘siphoned’ profits. No penalties, no fees. Just cash “siphoned” from the profits of some of the largest mutual funds in the country.

“If you sign up now, you can get your first check on July 31…

“So how is ‘siphoning’ able to pay out huge income checks to you with the same low-risk attitude of a mutual fund?

“Because when you ‘siphon’ you’re actually lining up to receive indirect payments straight from the mutual funds themselves.”

It’s still hard to get through the logic here without lots of big question marks popping up above your head, cartoon-style … but they go on to describe this as if you’re buying something that they’re “secretly” buying instead of paying them for management, and therefore somehow these payments you’re getting are some kind of “indirect payment” from the mutual funds. Ooooohh, my head hurts.

Here, try their words:

“When these mutual funds continue to pile into their secret investment, you can use it to ‘siphon’ off profits, every month.

“Don’t worry, this isn’t some fly-by-night investment fad.

“In fact, ‘siphoning’ has crushed the S&P 500 over the past 14 years, making double the money… even in a down market.

“So what is this secret investment?

“How Section 7704(d) of the Internal Revenue Code Can Pay You

“The Tax Reform Act of 1986 and the Revenue Act of 1987 created a special business sector in the United States.

“Mostly devoted to the natural resource industry, these businesses get a unique tax break outlined in Section 7704(d) of the Internal Revenue Code.

“The companies covered under Section 7704(d) do not have to pay corporate taxes. Because their industry is deemed vital to the future of the United States, they get a hugely beneficial tax break…

“With one condition: 90% of the profits must be redistributed back to shareholders….

You can see why mutual funds love these investments. And now you can profit off their love by ‘siphoning’ mutual fund money through these investments.

Nope, still hurts. I can tell you what they’re teasing, of course, but I can’t make the logic linear for you at all … sorry.

They’re teasing Master Limited Partnerships, which we’ve seen teased by just about every energy and income newsletter over the past couple years — and I’ve got no qualms with that, I own some MLP shares myself and even profiled one of the stranger ones for my paying members a while back.

And the teaser implies that one of the reasons you’ll continue to outperform mutual funds is because although they’re buying MLP shares as well and making lots of money from their “secret” investment in this sector, they have to diversify so they can’t focus just on this type of investment (as if you should).

Here’s how they explain that little tiptoe through the tulips:

“For example, as of November 2009, Oppenheimer’s Main Street Fund held nearly 2 million shares of Enterprise Products Partners.

“Those shares were worth over $58 million. And over the past six months alone they’ve increased 13.7% in value.

“But that hasn’t seemed to help the fund.

“Oppenheimer’s Main Street Fund is down over 5% over that same period. And shares in Oppenheimer, the parent company, are down nearly 10%.

“If that portion of the fund’s investment did so well, why don’t these funds put all of their money into this investment?

“The truth is, they can’t. Mutual funds diversify their holdings to minimize risk and to make their shareholders feel safer.

“If a mutual fund were to advertise that 100% of their money was in one company, who would buy that mutual fund? You would just buy the company and save the fees.

“So they try to spread the fund out amongst a multitude of investments. And they aren’t able to stay in this one investment, collecting 63% a year.

“But you don’t have to play by the mutual fund industry’s rules. You can invest in one of these companies and collect the juicy returns.

“In fact, the more mutual funds that plow shares into the investment, the higher your return will be.”

OK, we’ll take that at face value: If you just buy one of a mutual fund’s better performing stocks, you’re going to do better than the mutual fund. There’s a flip side, of course, but we’ll leave that to you.

You’re waiting for something to buy to profit from these MLPs though, right? We’ve talked about dozens of them over the years, and there’s a lot to like about these firms that mostly own energy infrastructure assets (pipelines, storage, etc.) and pay out most of their cash flow to shareholders with almost total tax deferral.

But then the teaser gets interesting, because they’re not just touting one of the big-name MLPs like Enterprise Products Partners (EPD) or Kinder Morgan (KMP). Apparently, there’s a “Siphon Fund” …

“These kinds of gains are nearly impossible to make just ‘siphoning’ off one of these mutual funds. You need to ‘siphon’ from as many as possible.

“Luckily, I’ve found a way to do that in just one step. I call it the ‘Siphon Fund.’

“It works like a mutual fund in some ways — but with no fees or performance payments. There’s no minimum investment. You can put in as much or as little as you want.

“You purchase the ‘Siphon Fund’ on the stock market like any other investment. And your returns are still tax-deferred.

“But the ‘Siphon Fund’ doesn’t profit from just one mutual fund’s investment.

“It actually ‘siphons’ from multiple mutual funds at the same time…

“Instead of collecting 30% yearly returns by ‘siphoning’ off just one mutual fund… You hoard all that income together, which would have made you 123% over the past two years.

“And remember, you’ll collect these checks every month, for the foreseeable future…

“If you get in today, you can get your first ‘siphoned’ check as soon as July 31.

“But don’t call your broker and expect him to known anything about the “Siphon Fund.” He’s probably never heard of it. And if he has… he won’t tell you.”

So what the heck is this? Master Limited Partnerships trade like stocks, but they’re not really stocks — they’re partnership units in these companies that own (usually energy-related) assets like pipelines, storage facilities, even propane distributors or tanker ships. And there is some connection to mutual funds and the envy mutual fund managers used to feel about MLPs and their market-beating performance in recent decades — but it’s just that mutual funds in the past weren’t allowed to own MLPs because of some tax rules. Still, that rule changed about three years ago and funds are welcome to own MLPs now if they like, though it arguably hasn’t exactly been a rush to the door — most MLPs are still overwhelmingly owned by individual investors, largely since that’s who benefits most from the tax advantage and the regular return-of-capital income.

And, as you might imagine, there are funds of MLPs available as well — the exchange-traded fund revolution hasn’t skipped by this sector. BUT — and this is a fairly substantial “but” (insert your own joke here) — there isn’t a direct index ETF for the sector.

There are several diversified ways to buy MLPs with a single investment, which seems clearly to be what’s teased here — though all of these ways do, indeed, involve paying a substantial fee for management, there are no cheap index funds in the MLP space. The most well-known index for Master Limited Partnerships is the Alerian MLP index, and the exchange-traded vehicle that’s available for that index is offered by JP Morgan, but it’s an Exchange Traded Note, not a fund. The difference is that this is really an exchange traded bond offered by JP Morgan, which trades as a promise on JP Morgan’s part to track the value of the index, and to pay you income based on the disstributions spit out from the component MLPs in that index (minus the management fee, which is a pretty high .85%)

Still, though, once you start looking at the closed-end funds in the MLP arena that .85% starts looking kind of cheap — these are high-income investments, and investors tend to be quite loyal as long as they get a good dividend, so many folks don’t realize (or care) about the often insanely high management fees charged by the closed end funds, sometimes as high as 3-4%.

Here are the closed-end funds I’m aware of, or the funds that are at least primarily invested in MLPs.

SRV Cushing MLP Total Return Fund
FEN Energy Income & Growth
FMO Fid/Claymore MLP Opportunity
KYE Kayne Anderson Energy Trust
KYN Kayne Anderson MLP
MTP MLP & Strategic Equity Fund
TYY Tortoise Energy Capital
TYG Tortoise Energy Infrastructure
TYN Tortoise North American Energy

Do note that as far as I can tell, all except MPT carry leverage (meaning, the fund borrows money to amplify its returns, often about 20-30% of net asset value), and MPT is also by far the cheapest (expense ratio around 1.35%, the others are all in the 3-5% range), and the only one that currently trades near the net asset value. It also, not surprisingly, has the lowest yield at a bit over 5% — which makes sense, since they’re not borrowing money to amplify that yield, the average yield for the index is about 7% and the management fee is taken out of that income. That’s why the JP Morgan ETN is a little bit of a higher-yielder, they’ve got essentially the same components but the ETN has a .85% fee, so the yield is more like 6%.

And in case you’re finding MPT compelling in that group, do note that their mandate allows them to get a bit more tricky — they can trade derivatives, so although they got out of that (in the form of selling forward contracts) during the market crash, they could always start it up again as a way of leveraging their portfolio … and I don’t know that they’re forbidden from borrowing per their prospectus, they just reportedly don’t have any leverage right now.

There is hope for a “real” MLP ETF coming sometime soon, ALPS Advisors has filed for an ETF to track part of the Alerian Index, though there aren’t many details available yet and I don’t imagine it’s a sure thing that it will go forward.

If this MPT closed end fund really is the solution that the Safe Haven Investor folks are teasing — and it’s my best guess based on the limited clues — then yes, they do pay monthly and the monthly distribution is paid on the last day of the month (it will be 7 cents for this month), with an ex dividend date of about two weeks before the payment date (so technically, you’ve got a couple days left to catch the June dividend if you’re so inclined — though remember, it’s only seven cents on a fund that’s currently priced at about $15.60 (as of today that’s a 5.3% annualized yield, by the way).

And according to a quick look at MTP’s annual report, it looks like — just like the MLPs themselves — they do classify substantially all of the distributions as a “return of capital.” So that means you do get a similar tax advantage when buying this fund — your “dividends” are really “return of capital distributions” … so instead of being taxable when you receive the income they just reduce your cost basis in the shares (meaning that when you sell, you’ll owe that much more in capital gains).

Personally, if I were to commit more of my portfolio to MLPs I’d probably just want to buy three or four of the relatively large ones (I currently own one). Since many investors treat MLPs as buy-and-hold income investments, or investments that can provide serious dividend reinvestment leverage over time, and because almost all of these partnerships tend to trade as a bloc anyway, it seems silly to pay over 1% for the privilege of having a fund choose them for you… or (with the ETNs) nearly 1% to have your tax-advantaged investments turned into taxable income.

Of course, with a closed-end fund or ETN (or ETF, if it eventually shows up) you do also get to sidestep the dreaded (by some) K-1s and the hassle and delay those partnership income forms sometimes bring to your tax-filing. Since each closed-end fund is a corporation, that corporation scrubs off the partnership hassle and passes along the dividend to you, which still may be “return of capital” but is apparently removed of the partnership responsibility — to be clear: I’M NOT A TAX EXPERT, this is just my opinion from reading up on the topic, so don’t count on me for the specifics that apply to you.

And there’s always room for active management that pays for itself, so if you’re sold on one of the closed-end funds that’s aggressive with leverage and distributions and charges a 4% fee, more power to you — it’s your money, and that strategy has certainly worked for some folks in the past (especially if they were able to buy those funds at a discount to net asset value, which is not currently an option).

The big picture is, as you’ll hear said by every investment newsletter that ever mentions this topic, is that MLPs as a group have beat the pants off of the S&P over the past 10 years and tend to have very predictable and growing distributions, so if income or stability matter to you they’ve probably got a place in most portfolios. Whether you want to buy a “siphon fund” to try to get that income and performance (assuming it continues), or just pick up a few MLPs for your taxable portfolio, is up to you.

If you’re curious about Safe Haven Investor, I’ve covered them a few times over the years — including the “special reports” they’re still teasing in this ad about “Crisis Bonds” and the “Gulf Coast Vaults.” A number of Stock Gumshoe readers have also shared their opinions about this newsletter with brief reviews — the reviews are not so hot but, to be fair, they came in just about a year ago so we might assume the performance was particularly poor right then.

P.S. If you want to know more, those articles that are quoted in the teaser are also available, though of course they don’t use the “siphon” term — there’s the Wall Street Journal article they quoted here, the Forbes article quoting James Early is here (Early is to some extent a competitor — he works for one of the Motley Fool income newsletters), and Barron’s did a nice article pushing MLPs back near the market bottom in October 2008, and they followed up on the “juicy yields” a little over a year ago.

Related Gumshoe Articles

Leave a Reply

11 Comments on "Siphoning: “Legally ‘Trick’ a Mutual Fund into Paying for Your Retirement”"


Mary Ann
Mary Ann
June 14, 2010 9:44 pm

Good grief. Siphoning???? I'm in marketing and I would be embarrassed to describe these funds in that way. I own 5 MLP's and I also own KYE, and I am not "siphoning" anything.

June 14, 2010 7:47 pm

That whole teaser reads as if it was written by a Chinese nationalist with poor English writing skills. We get that all the time with our subsidiary workers in China. They will send e-mails saying things like, “It is much pleasurable to me that I can join into the teamwork, we all work harmony together and get big monies.”

June 15, 2010 12:59 pm
MLPs are great for income. Considering the pitiful interest payments available, this is a bononza. First, remember that I have previously warned of the possibility of the voracious appetite of the Obamaites for income, the life o MLPs may be limited. The mmediate benefits of tax deferment with later capitol gains tax can be offset if you hve tax loss carry overs from the past market debacle. IRAs and 401Ks do not get tax defered benefits but do not need them. However, I believe that those earning over $1000.00 in MLP payments are in a special bracket. Important, before buying… Read more »
June 15, 2010 8:53 am

How can I make money monthly on my investments?

June 15, 2010 7:53 pm

Is anybody aware of DRIP plan for MLP?

June 19, 2010 3:32 pm

Can you suggest any other funds (mutual, CEFs, etc.) that pay in return of capital to benefit those with high capital loss carryovers.

One I found was OLA which yields over 11% and has high cap loss carryovers. ALSK (stock) also is mostly return of capital.

I am searching for others but do not know how to find them.

Gravity Switch
June 15, 2010 1:11 pm

Much thanks for your comment of illuminating. 🙂

Gravity Switch
June 15, 2010 1:13 pm

Thanks Herach — the UBTI thing is always massively confusing, it only becomes an issue with pretty big MLP positions but there are all kinds of rules about filing a return even if your gross UBTI is high enough, and filing a return for that sounds like an extra special nightmare. If I were buying MLPs now I'd personally prefer to buy the ETN in an IRA or individual MLPs in taxable accounts.

Gravity Switch
June 15, 2010 1:20 pm

(Though to be fair, when I speak Spanish I sound like a pre-schooler who got dropped on his head a few too many times … and I know not a word of Mandarin)

Mary Ann
Mary Ann
June 15, 2010 5:38 pm
The UBTI is the reason I hold my MLP's in a taxable account, and the KYE in an IRA. My understanding so far is that the possible change in taxation of MLP's has to do with carried interest. Here is what Elliiot Gue and Roger Conrad have to say. I copied this from an article in Seeking Alpha. "Here’s where it gets a bit complicated. Carried interest paid to general partners represents a share in the income produced by the partnership and is taxed accordingly. Thus, if that carried interest is generated by buying and selling financial assets such as… Read more »
Gravity Switch
June 15, 2010 9:32 pm

I don't know of any MLPs that do this directly (ie, you can buy direct from them instead of a broker), but there may well be some … and of course, probably all of them will let you reinvest dividends quite easily through a broker, and most brokers I've used don't charge for that. There are two MLPs, KMR and EEQ, that issue their distributions as new shares and not in cash (which is also a bit easier for taxes, arguably — those two usually trade at a discount to their "normal" MLP sisters KMP and EEP).