|By Fisher Investments Research Staff, 11/26/2013|
With interest rates on everything from savings accounts to junk bonds at or near generational lows, many income-seeking investors are looking for creative or, to some, exotic means of generating cash flow. Some are turning to a relatively little-known type of security—master limited partnerships (MLPs). MLPs may attract investors for a number of reasons: their high dividend yields and tax incentives, to name a couple. But, like all investments, MLPs have pros and cons, which are crucial to understand if you’re considering investing in them.
MLPs were created in the 1980s by a Congress hoping to generate more interest in energy infrastructure investment. The aim was to create a security with limited partnership-like tax benefits, but publicly traded—bringing more liquidity and fewer restrictions and thus, ideally, more investors. Currently, only select types of companies are allowed to form MLPs—primarily in energy transportation (e.g., oil pipelines and similar energy infrastructure).
To mitigate their tax liability, MLPs distribute 90% of their profits to their investors—or unit holders—through periodic income distributions, much like dividend payments. And, because there is no initial loss of capital to taxes, MLPs can offer relatively high yields, usually around 6-7%. Unit holders receive a tax benefit, too: Much of the dividend payment is treated as a return of capital—how much is determined by the distributable cash flow (DCF) from the MLP’s underlying venture (e.g., the oil pipeline).
When the Fed kept quantitative easing (QE) in place last week, US investors weren’t the only ones (wrongly) breathing a sigh of relief. Taper terror is fully global! In Emerging Markets (EM), many believe QE tapering will cause foreign capital to retreat. Some EM currencies took it on the chin as taper talk swirled over the summer, and many believe this is evidence of their vulnerability—with India the prime example as its rupee fell over 20% against the dollar at one point. Yet while taper jitters perhaps contributed to the volatility, evidence suggests India’s troubles are tied more to long-running structural issues and seemingly erratic monetary policy—and suggests EM taper fears are as false as their US counterparts.
The claim QE is propping up asset prices implies there is some sort of overinflated disconnect between Emerging Markets assets and fundamentals—a mini-bubble. Yet this is far removed from reality—not what you’d expect if QE were a significant positive driver. Additionally, the thesis assumes money from rounds two, three and infinity of QE has flooded into the developing world—and flows more with each round of monthly Fed bond purchases. As Exhibit 1 shows, however, foreign EM equity inflows were strongest in 2009 as investors reversed their 2008 panic-driven retreat. Flows eased off during 2010 and have been rather weak—and often negative—since 2011.
Exhibit 1: Emerging Markets Foreign Equity Inflows
With investors expecting the Fed to end quantitative easing soon, the yield spread is widening—fuel for stocks! Photo by Alex Wong/Getty Images.
Since 1932, the average S&P 500 bull market has lasted roughly four and a half years. With the present bull market a hair older than the average—and with domestic and global indexes setting new highs—some fret this bull market is long in the tooth. However, while bull markets die of many things, age and gravity aren’t among them. History argues the fundamentals underpinning this bull market are powerful enough to lift stocks higher from here, with economic growth likely to continue—and potentially even accelerate moving forward as bank lending increases.
|By Christo Barker, 10/10/2013|
While the rest of the country fretted over taper terror, government shutdown and debt ceiling limits, the Federal Reserve tested its Fixed Rate Full-Allotment Reverse-Repo Facility (a mouthful—let’s call it FARRP) for the first time September 24. FARRP allows banks and non-banks, like money market funds and asset managers, to access Fed-held assets—i.e., the long-term securities bought under the Fed’s quantitative easing—via securities dealers’ tri-party repo (and reverse-repo) market for short-term funding. (More on repos to follow.) FARRP aims to address what many feel is a collateral shortage in the non-bank financial system caused by too much QE bond buying concentrating eligible collateral on the Fed’s balance sheet, where it doesn’t circulate freely. As a result, many private sector repo rates turned negative. But, should FARRP be fully implemented, the facility could actually hinder some assets (in this case, high-quality, long-term collateral like bonds) from circulating through the financial system—much like quantitative easing (QE) locked up excess bank reserves. A more effective means of freeing collateral in the repo market is tapering the Fed’s QE.
Repurchase agreements, or repos, are used to generate short-term liquidity to fund other banking or investment activity—a means to move liquidity (cash) from one institution to another. In a repo, one party sells an asset—usually long-term debt—agreeing to repurchase it at a different price later on. A reverse repo is, well, the opposite: One party buys an asset from another, agreeing to sell it back at a different price later. In both cases, the asset acts as collateral for what is effectively the buyer’s loan to the seller, and the repo rate is the difference between the initial and future sales prices, usually expressed as a per annum interest rate. The exchange only lasts a short while—FARRP’s reverse repos are overnight affairs to ensure markets are sufficiently funded. In the test last Tuesday, the private sector tapped the facility for $11.81 billion of collateral—a small, but not insignificant, amount.
FARRP’s first round is scheduled to end January 29, and during that time, non-bank institutions can invest between $500 million and $1 billion each at FARRP’s fixed overnight reverse-repo rates ranging from one to five basis points. A first for repo markets: Normally, repo and reverse-repo rates are free-floating, determined by market forces. Another of FARRP’s differentiating factors is private-sector need will facilitate reverse-repo bids instead of the Fed. Ideally, FARRP’s structure will encourage unproductive collateral to be released back into the system when it’s most needed—and new sources of collateral demand may help ensure this. Swaps, for example, are shifting to collateral-backed exchanges due to Dodd-Frank regulation—meaning more collateral will be needed to back the same amount of trading activity. Collateral requirements for loans will likely also rise.
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|By Arthur Levitt, The Wall Street Journal, 03/03/2015|
MarketMinder's View: Much of this is sensible—namely, that it makes zero sense to create a special “small cap exchange” free of many listing requirements applicable to larger firms. The notion of having two standards of regulation is bizarre to us, and it’s highlighted as well by the Emerging Growth Company provision of the JOBS Act exempting small firms from SarbOx 404 requirements. Why not just gut SarbOx nearly fully, which would not legalize fraud, but would reduce the costs of listing and compliance?
|By Ben McLannahan, Financial Times, 03/03/2015|
MarketMinder's View: We reckon banks and investors alike would enjoy more transparency on how the Fed deems which banks are “globally systemically important,” aka too big to fail, and slapped with higher capital requirements as a result. While the quantitative factors are easy enough to decipher based on the Fed’s releases, the qualitative factors make the entire exercise too opaque—making it difficult for banks on the bubble quantitatively to plan. Financials stocks have done fine with the status quo, so this is more the absence of a potential tailwind than anything else, but still, we have to wonder how loan growth might improve at midsized banks if they knew where they stood.
|By Stefan Riecher, Bloomberg, 03/03/2015|
MarketMinder's View: Quantitative easing (QE) hasn’t even begun, and already folks fear tapering! Good grief. The ECB has said they plan to buy roughly €60 billion in long-term assets monthly through September 2016, adding roughly €1 trillion to their balance sheet. They have also said it might be open-ended, depending, and we all know from experience that central bankers are really good at changing their minds as conditions (and their interpretations of them) change. So who knows what will happen, but we think the eurozone will be better off the sooner QE ends. QE flattened yield curves in the US and UK, weighing on lending and growth. It probably has the same anti-stimulus effect in the eurozone, where yield curves are already quite flat. That said, the eurozone has already proven able to grow amid anemic lending and growth in the quantity of money, so QE shouldn’t derail the modest recovery.
|By Carl Richards, The New York Times, 03/03/2015|
MarketMinder's View: This has quite possibly the best graphic we have ever seen. And, quite sensibly, it encourages investors to judge advisers’ and brokers’ actions, not evaluate them based on which regulatory standard they adhere to. A few minor quibbles aside (i.e., it fails to differentiate between investment sales and service, and it doesn’t discuss how an adviser’s values and resources impact their ability to put clients first), this piece can help you separate client-focused investment professionals from those who are looking out for themselves first. For more on why this is necessary, see our 2/4/2015 commentary, “The DOL Gets a Homework Assignment.”
Market Wrap-Up, Monday Mar 2 2015
Below is a market summary as of market close Monday, 3/2/2015:
Global Equities: MSCI World (+0.2%)
US Equities: S&P 500 (+0.6%)
UK Equities: MSCI UK (-0.7%)
Best Country: US (+0.6%)
Worst Country: Portugal (-1.0%)
Best Sector: Information Technology (+0.9%)
Worst Sector: Utilities (-1.4%)
Bond Yields: 10-year US Treasury yields rose 0.09 percentage point to 2.08%.
Editors' Note: Tracking Stock and Bond Indexes
Source: Factset. Unless otherwise specified, all country returns are based on the MSCI index in US dollars for the country or region and include net dividends. Sector returns are the MSCI World constituent sectors in USD including net dividends.