MLP vs. Bonds

[moostachio]

Interested in advice about investing in MLP (Multiple Limited Partnerships e.g. like pipelines etc..) compared to bonds for the fixed portion of portfolio.  MLPs pay some nice dividends, not sure about the tax consequences and how that works compared to bonds, I think you have to file a special form at tax time too.

[aj_yooper]

The MLPs generally are sold by brokerage houses.  IMO, they pay the broker a large commission from your account and my experience is that they are crud, but they often have very flashy packets for buyers.  MLPs are also setup for storage buildings, movies, etc.  IMO, they are traps to catch your money so I don't buy them.

Bonds are different.  You have a choice of individual bonds, like EE, I bonds, individual issues (not very diversified), and bond funds (index and not-index).  Currently, I favor the short term investment grade index at Vanguard as it is diversified and has a short duration, meaning if interest rates go up, the fund will have a shorter time period to recalibrate to the new rate structure, unlike an intermediate or long term fund.  Our current low interest rate time means that bond funds purchased now will probably decline, corresponding to their bond duration, as interest rates eventually rise (But then, you will have the benefit of the new rate).  No one knows when that happens. 

[fiveoclockshadow]

Currently, I favor the short term investment grade index at Vanguard as it is diversified and has a short duration, meaning if interest rates go up, the fund will have a shorter time period to recalibrate to the new rate structure, unlike an intermediate or long term fund.  Our current low interest rate time means that bond funds purchased now will probably decline, corresponding to their bond duration, as interest rates eventually rise (But then, you will have the benefit of the new rate).  No one knows when that happens.

The flaw in this logic is it assumes the yield curve rises uniformly - which it almost assuredly will not.  In a rising interest rate environment the yield curve usually flattens - and right now there is a heck of a lot of room for flattening.  This means that while shorter term bonds have lower durations they will see greater interest rate increases than longer term bonds thus offsetting the impact of duration on NAV.  Meanwhile, as no one knows when this will happen (and it has been predicted for a few years now without occurring) the short term bond holder is losing out on returns generated by the longer bonds (especially since the yield curve is very steep right now).

Adjusting the duration of a bond portfolio is market timing - and we all know market timing doesn't work.  No free lunch here...

[aj_yooper]

So fiveoclockshadow, do you do the total bond index or intermediate term? 

*My bad.  The market timing thing did creep in, but I was thinking the decline in NAV in a short term bond would get fixed quicker in a ST fund versus Intermediate Term or the Total Bond.  I have read that advised LT bond funds do a little better than LT indexes.

[Undecided]

The MLPs generally are sold by brokerage houses.  IMO, they pay the broker a large commission from your account and my experience is that they are crud, but they often have very flashy packets for buyers.  MLPs are also setup for storage buildings, movies, etc.  IMO, they are traps to catch your money so I don't buy them.

Bonds are different.  You have a choice of individual bonds, like EE, I bonds, individual issues (not very diversified), and bond funds (index and not-index).  Currently, I favor the short term investment grade index at Vanguard as it is diversified and has a short duration, meaning if interest rates go up, the fund will have a shorter time period to recalibrate to the new rate structure, unlike an intermediate or long term fund.  Our current low interest rate time means that bond funds purchased now will probably decline, corresponding to their bond duration, as interest rates eventually rise (But then, you will have the benefit of the new rate).  No one knows when that happens.

What do you mean that MLPs "are generally sold by brokerage houses"? Public MLPs, like any other exchange-traded security, are sold on an exchange and, yes, for most people that means placing an order through a broker of some sort. Do you mean that primary offerings of MLP units are made through an underwriter? That's also no different than for a stock offering.

There is a huge range of MLPs, by focus, management, performance or whatever, as there is a huge range of traditional equity securities. MLPs generally have very different tax treatment than stocks or bonds. I don't see why they'd be a substitute for bonds in a big-picture sense, although I can understand why an investor looking for yield in today's market would look to MLPs as a substitute for bonds in that one regard.

[aj_yooper]

My experience with MLP has been with brokers who sell them to get the commission.  IMO, not usually a good strategy but YMMV.

[Undecided]

My experience with MLP has been with brokers who sell them to get the commission.  IMO, not usually a good strategy but YMMV.

OK, but don't be overly negative about a class of investment product on the basis of a bad experience with a salesperson.

[fiveoclockshadow]

So fiveoclockshadow, do you do the total bond index or intermediate term? 

Good question, my bond holdings are a little weird.  First I don't have that high an allocation to bonds (90/10 is where I'm at right now) so it lets me do some probably sort of silly things that make sense in theory but probably have little practical effect in the end...

The question of total or intermediate is a good one.  From what I've read about asset allocation it seems intermediate term has the lowest correlation with equity assets.  Long term while of course more volatile because of duration apparently also has higher correlation to equities (though I'm not sure I understand why).  So in that sense intermediate may be a better asset class for balancing equities than total bond because it is more effective per dollar.  Similarly short term is well correlated with cash instruments (savings accounts, CDs and the like) and so you could argue an emergency fund already covers the short end.

So a reasonable substitute for total bond might be intermediate bond fund, other short term instruments (e.g. CDs, high-yield savings, I bonds) and possibly ignore the long term bonds as they are too "equity like".

If your bond allocation is low enough you've got the I/EE bonds to consider as a significant chunk of your allocation (there are annual purchase limits which would be a limitation if you had a very large bond allocation).  I bonds clearly better than TIPS at the moment and EE bonds quite possibly the best long term treasury right now.  One feature of both is that they effectively expand your tax advantaged growth space leaving more space in your IRA/401k for other instruments.  And if you'll spend them on a child's education expenses they are tax free (assuming you don't make too much money).  I bonds are effectively a short term instrument.  EE right now very much a long term as their nominal rate is small but their guaranteed doubling at 20 years makes them similar to a tax advantage zero coupon bond (with an early escape at face value should you choose to).

One more wrinkle for those lucky enough to have a TSP account (I do) is the TSP G Fund.  These are essentially one day maturity bonds with an intermediate yield (2.125% right now).  Not sensible to hold any other short term instrument if you have these available right now.

So, because of the above my bond holding is a little wacky.  I've got a mixture of G Fund, VBILX (intermediate bond fund) and think I'm about to get some EE bonds (my daughter will be in college in 20 years and I hope to be retired well before then so I'll get tax free growth on them).  So in a sense I've got a "total bond holding" as far as maturities go but it is odd.  My short terms are G fund which are government only and totally abnormal in yield.  My long term is EE bonds because of specific tax advantages and I don't have an interest in much long term bonds anyway so this small holding of government only suits me.  The medium term are a fund mixed of government and commercial.

In the end I suspect all my cleverness will not amount to very much gained compared to either a total bond or intermediate bond holding.  But as far as tinkering with investments it is probably the least damaging way I could tinker with things ;)

[brewer12345]

My experience with MLP has been with brokers who sell them to get the commission.  IMO, not usually a good strategy but YMMV.

OK, but don't be overly negative about a class of investment product on the basis of a bad experience with a salesperson.

Good point.  Since neither William Bernstein and David Swensen comment on MLPs as core assets to use in a portfolio, I am taking that they are 'products' of financial engineers, not necessarily good or bad, but to me, suspect.  Motley Fool has a comment on MLPs:  http://beta.fool.com/ruperthargreav/2013/06/12/a-quick-rundown-of-master-limited-partnerships/33957/

In general, I follow William Bernstein's take on the brokerage and adviser industry:

"If you act on the assumption that every broker, insurance salesperson, mutual fund salesperson, and financial adviser you encounter is a hardened criminal, you will do just fine."  The Investor's Manifesto, p.142.

OK, let's get out the clue bat (whackety-whack).  MLPs are publicly traded entities that you can buy or sell just like any other stock at any discount browker (Fido, Schwab, TD, Vanguard, etc.).  They are subject to SEC scrutiny, have to make regular quarterly public reports, usually have quarterly earnings calls, etc.  There is nothing terribly different about them compared to any other public company except that they are organized as partnerships for tax purposes, rather than C corps (like most public companies).  Some basic info is available here: http://www.naptp.org/

I have made nice money buying and selling them in the past, but have stopped doing so because getting K1s is a pain in the ass come tax time.

[moostachio]

I appreciate everyone's input on the subject.  Right now I have just stocks and bonds, no MLP's.  I was thinking of further diversification and MLP's seemed pretty interesting, in particular because of the sizeable and stable dividend of some of them.

Another interesting area is REITs in particular those investing in Long Term health care, an area I would think with a bright future.  For the more "stable" component of the portfolio I have been really concerned lately about bonds, interest rates I would think could only go up, and on munis, Detroit, Chicago, CA all have risks in that area.

I will keep reading :).

[KingCoin]

I've owned in the past, but like brewer12345, filling out the rather complicated K1 became too much of an annoyance to justify smallish positions.

Most of the juicy yield MLPs have some catch, so it's crucial to understand exactly what you're buying and how the payout is determined. For instance, as soon as the oil well dries up, so does your payment stream. Some have a payout ratio that steps down at some point in the future. etc. etc. These aren't below the radar of major investors, so don't think that you're the only one who's noticed XYZ security has a 9% yield. It has 9% yield for a reason. Seekingalpha.com has some decent write-ups on individual MLPs.

[beltim]

My experience with MLP has been with brokers who sell them to get the commission.  IMO, not usually a good strategy but YMMV.

OK, but don't be overly negative about a class of investment product on the basis of a bad experience with a salesperson.

Good point.  Since neither William Bernstein and David Swensen comment on MLPs as core assets to use in a portfolio, I am taking that they are 'products' of financial engineers, not necessarily good or bad, but to me, suspect.  Motley Fool has a comment on MLPs:  http://beta.fool.com/ruperthargreav/2013/06/12/a-quick-rundown-of-master-limited-partnerships/33957/

In general, I follow William Bernstein's take on the brokerage and adviser industry:

"If you act on the assumption that every broker, insurance salesperson, mutual fund salesperson, and financial adviser you encounter is a hardened criminal, you will do just fine."  The Investor's Manifesto, p.142.

OK, let's get out the clue bat (whackety-whack).  MLPs are publicly traded entities that you can buy or sell just like any other stock at any discount browker (Fido, Schwab, TD, Vanguard, etc.).  They are subject to SEC scrutiny, have to make regular quarterly public reports, usually have quarterly earnings calls, etc.  There is nothing terribly different about them compared to any other public company except that they are organized as partnerships for tax purposes, rather than C corps (like most public companies).  Some basic info is available here: http://www.naptp.org/

I have made nice money buying and selling them in the past, but have stopped doing so because getting K1s is a pain in the ass come tax time.

Good use of the clue bat (the ignorance equivalent to the bad-decision facepunch?).  My head was spinning reading some bizarre commentary before yours.

To the original poster: MLPs are nothing more than companies organized under a different tax structure.  They're like REITs - if it weren't for the fact than MLPs tend to be (but are far from uniformly) in one industry, there would be no difference in terms of "asset class" between MLPs, REITs, and "regular" stocks.  However, there are some substantial tax differences, and I'd recommend doing some substantial research on the tax differences before investing.  But the most important thing to remember is that investing in MLPs is like investing in stocks, NOT like investing in bonds.  They should be considered part of your equity portfolio, not your income/bond portfolio.