|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 Eduardo Porter, The New York Times, 03/04/2015|
MarketMinder's View: Saving more? Nope. Evidently the real issue is that Wall Street is “bleeding savers dry” through high fees on actively managed mutual funds, putting retirees in jeopardy no matter how much they save. The proposed solution is a uniform fiduciary standard—previewed by the White House last week—which we are told would nudge every broker or investment adviser into selling or recommending index funds. Ipso presto problem solved. Except, we have our doubts. The fiduciary standard doesn’t require advisers to recommend the lowest-cost products. A broker or adviser who believes a higher-cost fund provides the best overall chance of reaching their client’s goals can recommend that fund and remain compliant. Rules don’t determine behavior, costs or returns. A firm’s values, resources, cost structures, philosophy and expertise do that. Heck, a fool held to the fiduciary standard may recommend an incorrect asset allocation, which slews of academic studies show matter much more then fees. Or maybe mix indexes within equities, resulting in subpar returns despite “indexing.” Folks, it ain’t all about the fees. For more, see last Tuesday’s commentary, “The DOL Gets a Homework Assignment.”
|By Asjylyn Loder, Bloomberg, 03/04/2015|
MarketMinder's View: That the oil industry’s bizarre application of mark-to-market accounting has delayed writedowns of firms’ proven reserves is an interesting factoid. But it is very, very tough to imagine any investors being blindsided when producers finally begin booking losses in a few months. Markets pretty efficiently price in widely known information, and oil’s fall is extremely well-known. Not a surprise. And given how Energy stocks have suffered recently, markets are probably well aware of all this.
|By Ambrose Evans-Pritchard, The Telegraph, 03/04/2015|
MarketMinder's View: Basically, Austria’s Carinthia region—an Alpine hamlet—is the new Ireland and Detroit wrapped in one. It holds about €10.2 billion in bonds used to recapitalize failed lender Hypo Alpe Aldria, which lost its state lifeline yesterday, forcing losses on creditors and shareholders. So now it’s on the hook for the bank’s debts (Ireland) and on the verge of bankruptcy (Detroit). While it might be tempting to draw broader conclusions about Austria’s solvency and the eurozone, as this piece tries to do, we think that’s a bridge too far. Ireland didn’t break the eurozone—it was the first bailed out country to heal. The US economy and stocks have yawned over Detroit’s bankruptcy since it went bust in 2013. As this piece notes, Austria’s borrowing costs remain among the world’s lowest. This is a tempest in a teapot.
|By Daisy Maxey, The Wall Street Journal, 03/04/2015|
MarketMinder's View: Several pros seem to think the best way to navigate rising interest rates after the Fed hikes is to concentrate in short- and long-term bonds, because long rates probably won’t budge much (less interest rate risk), while short-term bonds (one year or less) can (theoretically) be continually rolled over at higher rates. To each their own, and we happen to agree long rates aren’t likely to jump this year. But it just seems odd to ignore total return at the short end and embrace it at the long end. For folks using bonds as a tool to mitigate expected short-term volatility in a blended portfolio, we’d suggest viewing fixed income more holistically and managing the entire bucket for total return, paying reference to risk and return at all segments of the yield curve and in all major categories.
Market Wrap-Up, Wednesday Mar 4 2015
Below is a market summary as of market close Wednesday, 3/4/2015:
Global Equities: MSCI World (-0.4%)
US Equities: S&P 500 (-0.4%)
UK Equities: MSCI UK (-0.3%)
Best Country: Belgium (+0.2%)
Worst Country: Portugal (-3.4%)
Best Sector: Health Care (+0.2%)
Worst Sector: Materials (-0.9%)
Bond Yields: 10-year US Treasury yieldswere unchanged at 2.12%.
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.