New ETN Doubles Your Income

| July 16, 2010

Income investors are a unique breed.  Their primary goal is to generate income from their investments to cover living expenses.  But at the same time, they need to avoid losses to keep their nest eggs intact.

Here’s the problem…

With interest rates at historic lows, safely generating income has become much more difficult.  According to one study, the 100 biggest money market funds are currently paying an average of 0.5%…

At 0.5%, a $1 million nest egg only generates $5,000 a year… not exactly enough to live the good life or even cover basic living expenses for that matter.

Clearly, income investors must look for higher yields elsewhere.  Many are turning to long term U.S. Government Bonds.  They see these as safe investments that can produce more income.

Not so fast my friend…

It’s true the U.S. government isn’t going to default on its debt payments anytime soon.  But that’s where the “safety” of government bonds ends.

What many investors don’t understand is how much of their nest egg they can lose when interest rates start to rise.

It’s simply the way financial markets work.  When yields rise, prices fall. And the effect is more dramatic on longer term bonds like 30-year Government Bonds.  It could and probably will lead to major capital losses for income investors with large treasury holdings.

So what’s an income investor to do?

Take a look at Master Limited Partnerships or MLPs.

A MLP is a unique investment.  It’s taxed like a limited partnership, but the investment units are traded just like stocks.

Some of the most intriguing are energy infrastructure MLPs.  These MLPs generate a majority of their income from the transportation and storage of energy commodities.  They offer higher yields than Treasuries.  And they won’t lose value if interest rates go up.  (However, they can lose value if demand for energy declines.)

It’s no secret the price of commodities like oil and natural gas is very volatile.  But demand for these commodities is much less volatile than their price.  In fact, the cash flows from energy infrastructure MLPs are relatively consistent and predictable.

This makes the dividends paid by Energy Infrastructure MLPs consistent as well.

There are several MLPs I like right now.  Kinder Morgan Energy Partners LP (KMP), Enterprise Products Partners LP (EPD), and Enbridge Energy Partners LP (EEP) just to name a few.  They all offer yields around 7%.  Far better than what you’ll get in a money market or even Treasuries.

Many income investors have stayed away from MLPs because of their tax implications and for good reason.  Owning a MLP is more involved than owning a stock.

Without going into too much detail, here’s the main difference.  Dividends on MLPs are only taxed at the individual level.  This is different than corporate dividends that are taxed at the corporate and individual level.

That means dealing with K-1 tax forms.  It can create a big headache when income tax season rolls around.

But a new ETN (Exchange Traded Note) from the Swiss investment bank, UBS (UBS), gets rid of the MLP tax headache.  And it doubles the yield on Energy Infrastructure MLPs.

Introducing the UBS E-TRACS 2x Leveraged Long Alerian MLP Infrastructure Index (MLPL).

MLPL began trading just last week.  The ETN tracks an index of 25 Energy Infrastructure MLPs.

Here’s how it works.

MLPL is a debt security issued by UBS designed to track an index of MLPs.  In return for buying shares of MLPL, UBS promises to pay investors twice the return and income of the index.

The current yield on the index is 6.87%.  But MLPL pays out twice as much.  The current annual leveraged yield is a whopping 12.89%!  Now that’s some serious income!

And since you’re investing in an ETN, not the MLPs directly, the income is taxed as ordinary income on a 1099.  No K-1 tax headaches with MLPL!

One other important note on leverage.  Many leveraged ETFs and ETNs compound on a daily basis.  But MLPL only compounds once a month.

By compounding less frequently, the negative impacts of daily rebalancing are diminished.  It makes MLPL less volatile and a better option for your long term holdings.

All in all, MLPL is a great way to generate meaningful income.  It offers a much higher yield than money markets and Treasuries.  And now you can do it without the headache of dealing with K-1s at tax time.  (Sounds like a win – win situation to me.)

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Category: ETFs

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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