Generally CEFs trade at a discount to their NAV. Many use leverage to amplify their yields but this can be detrimental if interest rates rise.

Taxes

Part of the taxes are at interest level whereas other parts are the dividend level. This is good news since some of the dividends may be taxed at the 15% level. The preferred provider should have the tax information on their website.

Risks

The risks abound.

Interest rates
Hedging strategy risk
Credit risk
Liquidity risk
Leverage risk
Securities lending risk
Industry concentration risk
Preferred securities risk
Credit securities risk
Debt securities risk
Credit derivatives risk
Market discount risk
Management risk
Below investment grade securities risk
Conversion risk
Anti-takeover provisions
Market disruption
Inflation risk
Deflation risk
Tax risk
Foreign security risk
Portfolio turnover risk

Risk is inherent in all investing. Investing in any investment company security involves risk, including the risk that you may receive little or no return on your investment or even that you may lose part or all of your investment. Therefore, before buying shares of the Fund you should consider carefully the following risks that you assume when you invest in shares of the Fund’s Common Stock:

Interest Rate Risk. Fixed income securities typically decline in value when correlated interest rates rise and increase in value when correlated interest rates fall. Changes in the level of long-term interest rates are expected to affect the value of the Fund’s portfolio holdings of fixed rate securities and, under certain circumstances, its holdings of adjustable rate securities. Subject to certain limitations described herein, the Fund currently anticipates hedging, from time to time, some or all of its holdings of fixed rate and adjustable rate securities, for the purposes of (1) protecting against declines in value attributable to significant increases in long-term interest rates and (2) providing increased income in the event of significant increases in long-term interest rates while maintaining the Fund’s relative resistance to a reduction in income in the event of declines in long-term interest rates. There can be no guarantee that such hedging strategies will be successful. Significant changes in the interest rate environment, as well as other factors, may cause the Fund’s holdings of preferred and debt securities to be redeemed by the issuers, thereby reducing the Fund’s holdings of higher income-paying securities at a time when the Fund may be unable to acquire other securities paying comparable income rates with the redemption proceeds. In addition to fluctuations due to changes in long-term interest rates, the value of the Fund’s holdings of preferred securities, and, as a result, the Fund’s net asset value, may also be affected by other market and credit factors, as well as by actual or anticipated changes in tax laws.

Hedging Strategy Risk. Certain of the investment techniques that the Fund may employ for hedging or, under certain circumstances, to increase income or total return will expose the Fund to risks. There are economic costs of hedging reflected in the pricing of futures, swaps, options, swaption contracts, and credit derivatives which can be significant. There may be an imperfect correlation between changes in the value of the Fund’s portfolio holdings and hedging positions entered into by the Fund, which may prevent the Fund from achieving the intended hedge or expose the Fund to risk of loss. In addition, the Fund’s success in using hedge instruments is subject to the Adviser’s ability to predict correctly changes in the relationships of such hedge instruments to the Fund’s portfolio holdings, and there can be no assurance that the Adviser’s judgment in this respect will be accurate. In addition to the hedging techniques described elsewhere, i.e., positions in Treasury Bond or Treasury Note futures contracts, use of options on these positions, positions in interest rate swaps and options thereon (”swaptions”), and positions in credit derivatives, such investment techniques may include entering into interest rate and stock index futures contracts and options on interest rate and stock index futures contracts, purchasing and selling put and call options on securities and stock indices, purchasing and selling securities on a when-issued or delayed delivery basis, entering into repurchase agreements, lending portfolio securities and making short sales of securities “against the box.” The Fund intends to comply with regulations of the Securities and Exchange Commission (and with the limitations of the Fund’s credit rating agencies in connection with the Fund’s leverage) involving “covering” or segregating assets in connection with the Fund’s use of options, futures and other derivatives contracts.

Credit Risk. Credit risk is the risk that an issuer of a preferred or debt security will become unable to meet its obligation to make dividend, interest and principal payments. In general, lower rated preferred or debt securities carry a greater degree of credit risk. If rating agencies lower their ratings of preferred or debt securities in the Fund’s portfolio, the value of those obligations could decline, which could jeopardize the rating agencies’ ratings of Fund Preferred Shares. In addition, the underlying revenue source for a preferred or debt security may be insufficient to pay dividends, interest or principal in a timely manner. Because the primary source of income for the Fund is the dividend, interest and principal payments on the preferred or debt securities in which it invests, any default by an issuer of a preferred or debt security could have a negative impact on the Fund’s ability to pay dividends on Common Stock. Even if the issuer does not actually default, adverse changes in the issuer’s financial condition may negatively affect its credit rating or presumed creditworthiness. These developments would adversely affect the market value of the issuer’s obligations or the value of credit derivatives if the Fund has sold credit protection.

Securities Lending Risk. Counterparty risk on the securities lending side of the transaction exists. Although risk is limited since the loan is collateralized by cash, the Fund could suffer losses if the counterparty fails to return securities that have risen in value. There is also investment risk on the proceeds from the securities loans: These monies are invested in short-term investments, and if those investments lose value, the Fund will still owe the amount borrowed.

Liquidity Risk. The Fund intends to invest in securities and derivatives contracts with varying degrees of market liquidity and may invest up to 20% of its total assets in illiquid securities. Preferred securities may be substantially less liquid than many other securities such as Government Securities, corporate debt, or common stocks. At any particular time, a preferred security may not be actively traded in the secondary market, even though it may be listed on the New York Stock Exchange or other securities exchange. Many preferred securities currently outstanding are listed on the New York Stock Exchange, although secondary market transactions in preferred securities are frequently effected in the over-the-counter market, even in those preferred securities that are listed. Over-the-counter derivatives contracts, including credit derivatives, also may be substantially less liquid than many other securities such as Government Securities, corporate debt or common stocks. They are not traded on an exchange, may not be actively traded, and are individual contracts between counterparties. The prices of illiquid securities and the market-to-market values of illiquid derivatives contracts may be more volatile than more actively traded securities or derivatives due to a variety of factors, such as there being fewer active buyers and sellers and the lower frequency of trading. The absence of a liquid secondary market may adversely affect the ability of the Fund to buy or sell its preferred securities or derivatives holdings at the times and prices desired and the ability of the Fund to determine its net asset value.

Leverage Risk. The Fund’s use of leverage through the issuance of Fund Preferred Shares creates an opportunity for increased Common Stock net income, but also creates special risks for Common Stockholders. There is no assurance that the Fund’s leveraging strategy will be successful. Risks affecting the Fund’s net asset value are magnified. If the Fund’s current net investment income and capital gains are not sufficient to meet dividend requirements on outstanding Fund Preferred Shares, the Fund may need to liquidate certain of its investments, thereby possibly reducing the net asset value attributable to the Common Stock. In addition, failure to meet required asset coverage requirements for Fund Preferred Shares to satisfy certain guidelines established by the rating agencies may result in mandatory partial or full redemptions of Fund Preferred Shares, which would reduce or eliminate the Fund’s leverage and could also adversely affect distributions to holders of the Common Stock. Such redemptions may also cause the Fund to incur additional transaction costs, including costs associated with the sale of portfolio securities.

Leverage creates two additional major types of risks for Common Stockholders:

* The likelihood of greater volatility of net asset value and market price of Common Stock because changes in the value of the Fund’s portfolio are borne entirely by the Common Stockholders; and
* The possibility either that Common Stock income will fall if the dividend rate on the Fund Preferred Shares or the interest rate on any borrowings rises, or that Common Stock income will fluctuate because the dividend rate on the Fund Preferred Shares or the interest rate on any borrowings varies.

When the Fund is utilizing leverage, the fees paid to the Adviser and other service providers will be higher than if the Fund did not utilize leverage because the fees paid will be calculated based on the Fund’s managed assets (which include the liquidation preference on any Fund Preferred Shares and the principal amount of any borrowings used for leverage).

Industry Concentration Risk. The Fund concentrates its investments in the utilities and banking industries. As a result, the Fund’s investments may be subject to greater risk and market fluctuation than a fund that had securities representing a broader range of investment alternatives. Banks and utilities are subject to such risks as changes in law, regulatory policies or accounting standards, regulatory restrictions, increased competition and general economic and political conditions.

Preferred Securities Risk. In addition to credit risk, investment in preferred securities carries certain risks including:

* Deferral Risk-Traditional preferreds contain provisions that allow an issuer, under certain conditions, to skip (in the case of “noncumulative” preferreds) or defer (in the case of “cumulative” preferreds) dividend payments. Fully taxable or hybrid preferred securities typically contain provisions that allow an issuer, at its discretion, to defer distributions for up to 20 consecutive quarters. If the Fund owns a preferred security that is deferring its distributions, the Fund may be required to report income for tax purposes while it is not receiving any income.
* Redemption Risk-Preferred securities typically contain provisions that allow for redemption in the event of tax or security law changes in addition to call features at the option of the issuer. In the event of redemption, the Fund may not be able to reinvest the proceeds at comparable rates of return.
* Limited Voting Rights-Preferred securities typically do not provide any voting rights, except in cases when dividends are in arrears beyond a certain time period, which varies by issue.
* Subordination-Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure in terms of priority to corporate income and liquidation payments, and therefore will be subject to greater credit risk than those debt instruments.
Liquidity-Preferred securities may be substantially less liquid than many other securities, such as U.S. government securities, corporate debt or common stock.

Debt Securities Risk. In addition to credit risk, investment in debt securities carries certain risks including:

* Redemption Risk-Debt securities may contain provisions that allow for redemption in the event of tax or security law changes in addition to call features at the option of the issuer. In the event of redemption, the Fund may not be able to reinvest the proceeds at comparable rates of return.
* Limited Voting Rights-Debt securities typically do not provide any voting rights, except in cases when interest payments have not been made and the issuer is in default.
* Liquidity-Debt securities may be substantially less liquid than many other securities, such as U.S. government securities or common stocks.

Credit Derivatives Risk. In addition to credit risk, investment in credit derivatives carries certain risks including:

* Counterparty Risk-Credit derivatives are contracts between a buyer and a seller (the counterparties) of credit protection. While credit derivatives are collateralized, there is risk that a counterparty will fail to make payments due under the terms of the contract at a time when there is insufficient collateral to compensate the Fund for the full value of the contract.
* No Voting Rights-Credit derivatives do not provide any voting rights, although the delivery of an underlying reference obligation may provide such rights.
* Liquidity-Credit derivatives may be substantially less liquid than many other securities, such as U.S. government securities, corporate debt, or common stocks.

Market Discount Risk. As with any stock, the price of the Fund’s shares will fluctuate with market conditions and other factors. Shares of closed-end investment companies frequently trade at discounts from net asset value. This characteristic of shares of a closed-end fund is a risk separate and distinct from the risk that the fund’s net asset value may decrease. The Fund cannot predict whether the Common Stock will trade at, above or below net asset value. The Common Stock is designed for long-term investors and should not be treated as a trading vehicle. For those investors, realization of gain or loss on their investment is likely to be more dependent upon the existence of a premium or discount than upon portfolio performance.

Management Risk. The Fund is subject to management risk because it is an actively managed portfolio. The Adviser will apply investment techniques and risk analyses in making investment decisions for the Fund, but there can be no guarantee that these will produce the desired results.

Lower-rated Securities Risk. The Fund may invest up to 25% of its total assets in its holdings of securities rated below investment grade at the time of purchase or judged to be comparable in quality at the time of purchase. Lower rated preferred or debt securities, or equivalent unrated securities, which are commonly known as “junk bonds,” generally involve greater volatility or price and risk of loss of income and principal, and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher grade securities. It is reasonable to expect that any adverse economic conditions could disrupt the market for lower-rated securities, have an adverse impact on the value of those securities, and adversely affect the ability of the issuers of those securities to repay principal, dividends and interest on those securities.

Conversion Risk. Under the Fund’s Bylaws, if at any time shares of the Common Stock publicly trade for a substantial period of time at a significant discount from the Fund’s then current net asset value per share, the Board of Directors of the Fund is obligated to consider taking various actions designed to reduce or eliminate the discount, including recommending to shareholders amendments to the Fund’s Articles of Incorporation (together with any amendments or supplements thereto, including any articles supplementary, the “Articles” or “Articles of Incorporation”) to convert the Fund to an open-end investment company, which would result in the redemption of Fund Preferred Shares then outstanding and the potential subsequent sale of Fund assets during unfavorable market conditions. In addition, the Board may consider taking actions designed to eliminate the discount whenever it deems it to be appropriate.

Anti-Takeover Provisions. The Fund’s Articles of Incorporation and Bylaws include provisions that could have the effect of inhibiting the Fund’s possible conversion to open-end status and limiting the ability of other entities or persons to acquire control of the Fund’s Board of Directors. In certain circumstances, these provisions might also inhibit the ability of shareholders to sell their shares at a premium over prevailing market prices.

Market Disruption. As a result of the terrorist attacks on the World Trade Center and the Pentagon on September 11, 2001, some of the U.S. securities markets were closed for a four-day period. These terrorist attacks and related events have led to increased short-term market volatility and may have long-term effects on U.S. and world economies and markets. A similar disruption of the financial markets could impact interest rates, auctions, secondary trading, ratings, credit risk, inflation and other factors relating to the Common Stock.

Inflation Risk. Inflation risk is the risk that the value of assets or income from the Fund’s investments will be worth less in the future as inflation decreases the value of payments at future dates.

Deflation Risk. Deflation risk is the risk that the Fund’s dividends may be reduced in the future as deflation reduces interest rates in general, resulting in higher-yielding assets owned by the Fund being redeemed by their issuers.

Tax Risk. Future changes in tax law or regulation could adversely affect the Fund and its portfolio holdings, including their valuation, which could negatively impact the Fund’s shareholders and distributions they receive from the Fund. Tax changes can be given retroactive effect.

Foreign Security Risk. The prices of foreign securities may be affected by factors not present with U.S. securities, including currency exchange rates, political and economic conditions, less stringent regulation and higher volatility. As a result, many foreign securities may be less liquid and more volatile than U.S. securities.

Portfolio Turnover Risk. The techniques and strategies contemplated by the Fund might result in a high degree of portfolio turnover. The Fund cannot accurately predict its securities portfolio turnover rate, but anticipates that its annual portfolio turnover rate will not exceed 150% under normal market conditions, although it could be materially higher under certain conditions. Higher portfolio turnover rates could result in corresponding increases in brokerage commissions and generate short-term capital gains taxable as ordinary income.

Master limited partnerships (MLP) are an alternative income producing asset that can grow like a stock. MLPs are partnerships that trade on major exchanges just like regular stocks.

List

ENP, KMP, LINE, ATN, OKS, PAA, NS, TPP, DEP, LINE, EROC, BBEP

Intro

MLPs pay no tax: they pass the dividends directly to you (so you pay the tax). Many MLPs allow depreciation so 80% to 90% of the profit they generate can be written off; in other words you do not pay tax on 80% to 90% of the distribution until you sell the MLP or the tax basis reaches 0. The rest of the distribution is taxed.

Focused MLPs, such as pipelines, are not correlated to the stock market (i.e. S&P 500) in general which adds stability to your portfolio.

Structure

MLPs have a general partner and limited partners. The general partner manages the operation and individual investors are limited partners. The general partner receives a percentage of the profits off the top, before the limited partners get their cut. MLPs, though, pay big dividends because they don’t have to pay federal income taxes if they pay out most of their cash flow to shareholders. Because MLPs are partnerships, not corporations, some special terminology is involved. Specifically, you own units instead of shares, and an MLPs payouts are called distributions instead of dividends.

Risks

The main threat to MLPs is an economic slowdown, which could reduce transportation volumes and demand for their services. U.S. energy demand is expected to grow at an average annual clip of about +1% over the next two decades, approximately what it has over the previous two.

Since MLPs give out substantially all of their cash to unitholders, they depend entirely on outside financing for growth initiatives.

The tax rate, such as qualified dividend rate, is raised.

While regulated pipeline operators offer stable cash flows, if competition increases, payments to investors could decrease. Regulated pipelines receive a tariff indexed to inflation. These payments also build in a +10-12% return for the operator. That said, the tariffs represent the top rate a company can charge its customers for shipping oil and gas. When competition heats up, companies will offer their services below the going rate.

One other thing to watch for are interest rates. MLPs generate stable cash flow whether interest rates move up or down. However, just like every other income-paying asset class, MLPs compete directly with lower-risk fixed-income investments. If lower-risk bonds offer equally-attractive returns, then investors will rotate money out of higher-risk MLPs and into lower-risk bonds.

Another caution: the hefty MLP management rake-off. Managers, who own a chunk of MLP shares and thus get the same nice dividends you do, also are entitled to increasing payouts as the distribution increases. Their take can reach as high as 50%. The idea is to motivate management to expand the business.

Rewards

The midstream energy sector has high barriers to entry. Due to the high cost of constructing midstream energy assets and the difficulty of developing the expertise necessary to comply with the regulations governing the operation of such assets, the barriers to entering the midstream energy sector are high. MLPs with large asset bases and significant operations enjoy a competitive advantage over others seeking to enter the sector.

Tax considerations

MLPs maximize their tax advantages by owning long-lived assets that generate lots of depreciation-mostly long-distance pipelines, but also riskier things like gathering systems (pipe that connects to wells), storage tanks, even barges. Partnerships also pay out nearly all of their cash flow. But thanks to those depreciating assets, most of these distributions are considered a return of capital. That means you generally aren’t taxed on MLP payouts until you sell, or until your total income exceeds your initial investment.

MLPs offer a possible tax advantage because roughly 80% to 90% of distributions are considered a return of your original investment (which is really just an allowance for depletion or depreciation) instead of income. Thats great if you are a long-term investor, because you don’t pay taxes on that part until you sell or your tax basis reaches 0. However, when you do sell, you pay taxes, mostly at ordinary income rates, on the portions previously designated as return of capital. The remaining 20% is the income portion and is generally taxed at your ordinary income tax rate the year it is received.

If the owner of the security passes away, the reduced cost basis is stepped up to the current share price. That makes MLPs good for estate planning purposes, since they don’t trigger a tax liability for your estate.

There is another complication if you hold MLPs in a tax-sheltered account such as an IRA. If you receive MLP distributions totaling more than $1,000 in a year, the amount exceeding that figure may be considered unrelated business income (UBTI) and subject to taxes. So consult with a tax expert if you fall into that category.

MLPs do not pay taxes, thus allowing for a higher cash flow payout to shareholders. This is different from regular corporations, which are subject to double taxation of dividends. The corporation’s earnings are taxed and then the stockholder’s dividends are also taxable. The amount of a MLPs distribution that is shielded from ordinary income taxes is generally expressed as a certain percentage of the distribution. As an example, an 75% tax-deferred distribution would indicate that on a $2.00 per unit annual distribution 75%, or $1.50, would be tax deferred and $0.50 would be taxed as ordinary income in the year received. The tax deferral percentage amount could slowly decline over the years. However, the amount deferred can vary depending on the amount of cash distributions, the number of shares outstanding and the amount of additional taxable income related to acquisitions or growth. This is important… acquisitions sort of reset (or increase) the amount of the tax deferred portion of the distributions.

The portion of a cash distribution that is not taxable must be subtracted from you original purchase price to compute your new cost basis. When you sell, some of your gain will be taxed at the lower capital gains rate, but the portion of the gain that results from deductions such as depreciation lowering your basis downwards will be taxed as ordinary income.

Cash distributions from MLPs reduce a unitholder’s tax basis in the investment and are not taxable to a unitholder as long as the unitholder’s tax basis in the MLP exceeds zero. Distributions are taxable to the extent they exceed a unitholder’s tax basis in the investment. Unitholders may also be subject to income tax reporting requirements in states in which the MLP has operations.

Distributions

Distributions are made on a quarterly basis so check your MLP for its distribution schedule.

Tax Forms

MLPs mail individualized K-1 tax forms to unitholders in late February or early March of each year. The K-1’s are not a big deal at all and most MLP’s have very helpful websites for dealing with these things. Cash distributions are not taxable but are treated as a reduction in a unitholders original cost basis in the investment. Since MLPs generally pay out more cash distributions than the amount of taxable income, the cost basis for each individual unitholder is decreased by the difference between total cash received and taxable income reported. The MLP form allows for the pass-through of depreciation (a non-cash expense) to unitholders. The cumulative tax-deferred portion of the distribution becomes taxable as ordinary income in the year the units are sold, allowing investors the flexibility to recognize taxable income in any given year.

MLPs require the use of special forms at tax time, which some investors consider too complicated. They are the K-1 partnership. The return of capital lowers your tax basis in the stock and thus raises your capital gain down the road. Schedule E: Supplemental Income and Loss, and out-of-state returns that may need to be filed for individual MLP securities. And depending on how the MLP deals with depreciation, you could get thrown into the harrowing alternative minimum tax.

State Taxes

Investors in MLPs that operate in several states must file in each state the MLP does business. This can be a cumbersome and laborious process. The tax material the partnership sends you should include a breakdown of your net income in each state where it operates. Usually the per-state amounts are pretty low, and you may be below the state filing threshold — but if not, you’ll need to file and pay state tax.

Here is a direct example:

Q: What states do I have to file tax returns in as a result of owning TC PipeLines, LP common units?

A: In addition to the filing requirements of the state in which you live, you may be required to file a non-resident tax return in the states in which the Partnership operates. The Partnership operates in eleven states, nine of which impose income tax on a Partner’s share of Partnership income allocable [sic] to such state. These state are California, Illinois, Indiana, Iowa, Minnesota, Montana, Nebraska, North Dakota, and Oregon.

Tax Example

You don’t pay taxes on the return of capital portion until you sell the security, making MLPs ideal for long-term investors. Return of capital distributions lead to a reduction in your cost basis. For example, if you pay $50 a share for an MLP and receive a $5 return of capital distribution this year, then the cost basis of your shares will decline to $45. Say you sell the shares next year at $55 a share. You will be taxed at your ordinary income tax rate on the $10 in capital gains ($55 less $45).

Another example
Original cost = $20

                2007     2008
cost basis     20.00    19.10
distribution    1.00     1.08
yield             5%       6%

10% taxable     0.10     0.11
90% deferred    0.90     0.97

Adj basis      19.10    18.13

Sale Price              27.00

Taxable gain             8.87
cap gains tax            7.00
ordinary income tax      1.87

cap gains rate = sale price - initial cost
ord. income rate = taxable gain - cap gains rate

Analysis Tools

To see the dividend history:
1 - go to finance.yahoo.com
2 - enter stock symbol
3 - historical prices > Dividends only > Get prices

Strategies

You can’t analyze an MLP the same as you would a regular stock. MLPs own lots of assets that result in large depreciation charges that subtract from reported earnings, but don’t affect the cash flow that fuels distributions. Your best prospects are MLPs with a strong distribution growth history and plenty of pipeline construction projects underway.

You can learn about an MLP’s expansion plans by reading the management summary portions of their quarterly and annual reports. You can see the SEC reports on Yahoo by selecting SEC Filings and then looking for reports labeled 10-Q (quarterly) and 10-K (annual). Once you’ve found a report, select Summary to read the management’s discussion.

Each MLP is operated by a general partner, who generally has a 2% ownership stake in the partnership and is eligible to receive incentive distributions. When evaluating an MLP, it’s smart to examine a partnership’s distributions agreements. Incentive distributions are typically based on achieving
predetermined pay out levels. Often general partners can earn between 15% and 50% of excess cash flow paid out above the target threshold.

Variations

There are four sectors of natural resource-related MLPs:
1- pipelines
2- propane distributors
3- coal
4- oil and gas exploration and production (E&P).

The pipeline MLPs are considered more conservative and are characterized by stable cash flow and slow growth. Propane distributors are more aggressive investments than pipelines. The propane industry is a non-regulated, seasonal, slow-growth industry with moderate exposure to commodity prices. Coal MLPs also have moderate exposure to commodity price volatility. However, their principal end-user customers are public utilities, thus, overall risk is considered relatively low. The riskiest are the E&P MLPs

Generally, the MLP distribution (similar to a dividend) is not guaranteed. Most MLPs (like corporations) have restrictive debt covenants, which can impair distribution payments if a default occurs.

Closed End MLP Funds

There are a few closed-end MLP funds. The following describes the major factors associated with them:

Pros

1. You get a diversified professionally managed portfolio of MLPs.
2. You get a single Form 1099 with a significant portion of the income considered as a tax-deferred return of capital. This is nondividend distributions and reduces the cost basis of shares owned.

Cons

1. The advisers are paid a fee, around 1% to 1.5%, and incur expenses associated with overseeing the fund investments.
2. These funds are structured as taxable corporations and as such, may incur income tax liabilities.
3. The funds generally use leverage, which would cause increased risk affected by rising interest rates.
4. Fees, taxes and interest expense will come from income available for dividends.

Tracking Indices

An index for MLPs exist called the Alerian MLP Select Index. Symbol is AMZ.
The website Alerian has more information on the index.

There is an ETN (exchange traded note) that tracks the Alerian MLP Select index under the symbol BSR. The investment seeks to replicate, net of expenses, the Alerian MLP Select Index. The index measures the performance of midstream energy oriented MLPs. These companies are engaged in the exploration, marketing, mining, processing, production, storage or transportation of any mineral or natural resource.

I have mixed feelings about mutual funds.

Pros

Diversification

Mutual funds over diversification over individual stocks.

Personal Benefits

check writing, bank transfers

Regular investments

mutual funds generally do not charge to invest money in them so someone wanting to invest on a regular basis can do so with no consequence.

Reinvestment

mutual funds are handy when you want to reinvest dividends as there is no charge.

Cons

Expense ratio

Managed funds usually have a high (over 1%) expense ratio.

Unrealized capital gains

The bane for taxable funds. When you buy mutual fund shares there may be capital gains already accrued. It is possible to buy fund shares one day and the next day have to pay on capital gains you did not benefit from.

Capital gain distributions

Most mutual funds have long and short capital gain distributions at the end of the year, generated by buying and selling stocks. Even if there is no gain (or a loss) on the mutual fund you still have to pay the capital gains tax. You have no control when a fund buys or sells stocks - it is to meet their need, not yours.

Trading woes

Once purchased, you are liable for any capital gain/losses when you sell.
Reinvested dividends do not add to the cost basis as you have already paid tax on them.

Fund Manager revolving door

there is no guarantee that a star fund manager will stay with a mutual fund.

Preferred stocks (PS) generally pay above average (over stocks and bonds) fixed income, usually quarterly. Many are taxed at the 15% dividend rate rather than income rate.

Four types of preferred stock exists: cumulative preferred, noncumulative, participating, and convertible.

Generally utility companies, financial, and REITS issue preferred stock.
Preferred stocks are rated by agencies such as Moody or Standard and Poor based on the creditworthiness of the issuing corporation.

Cumulative Preferred

Cumulative preferred stock has its dividends accumulate in case the company decides to restore them. They must be paid off before common stock dividends.

Noncumulative Preferred

Noncumulative preferred stock does NOT have its dividends accumulate so if the company decides to restore paying they do not have to pay any dividends in arrears.

Convertible

PS can be converted into common stock.

Participating

Participating preferred stock gives the holder the right to receive an additional dividend based on some predetermined condition.

The additional dividend paid to preferred shareholders is commonly structured to be paid only if the amount of dividends that common shareholders receive exceeds a specified per-share amount.

Furthermore, in the event of liquidation, participating preferred shareholders can also have the right to receive the stock’s purchasing price back as well as a pro-rata share of any remaining proceeds that the common shareholders receive.

For example, suppose Company A issues participating preferred shares with a dividend rate of $1 per share. The preferred shares also carry a clause on extra dividends for participating preferred stock, which is triggered whenever the dividend for common shares exceeds that of the preferred shares.

If, during its current quarter, Company A announces that it will release a dividend of $1.05 per share for its common shares, the participating preferred shareholders will receive a total dividend of $1.05 per share ($1.00 + 0.05) as well.

Participating preferred stock is rarely issued, but one way in which it is used is as a poison pill. In this case, current shareholders are issued stock that gives them the right to new common shares at a bargain price in the event of a hostile takeover bid.

Pros

Above average income

Preferred stock generate above average income over stocks and bonds.

Issue principal returned

Most preferred stocks return their original issue price (usually $25) when called. An investor can make capital gains if the preferred was purchased below the call price. Of course, the investor can always sell the stock.

Dividends are paid before common stock holders

Some income is classified as dividends

Many preferred’s dividends qualify as true dividends so they are taxed at the 15% dividend rate rather than income rate.

Dividend paid at a fixed rate

Most preferreds pay dividends at a fixed rate, usually a percentage of par value, but may be suspended if the company cannot pay them. There are floating dividends, too.

Corporations get a tax break

Corporations only have to pay tax on 30% of the dividend received which makes it a great investment for corporations.

Cons

Dividends not adjusted to inflation

Since dividends are fixed they are not adjusted for inflation.

No voting rights

Though the owner of preferred stock has a stake in the company, he has no voting rights.

Dividends are paid out of after tax funds

A company pays preferred stock dividends out of money that has already been taxed.

Preferred stock can be called

Nearly every preferred stock as a call provision in it, generally 5 years, so if interest rates go down they can call the stock and reissue at lower rates. The call price is usually the par value (i.e. the original purchase price).

No maturity date

Most PSs are issued in perpetuity. If the interest rate increases, the price of the PS decreases; just like a bond. Since there is no maturity date on PS the price may stay low for years whereas as a bond’s maturity date nears the price of the bond increases toward its par value.

Details

Make sure you understand all the details of the preferred stock, such as its class, call provisions, dividend classification, before investing.

Preferred Stock Mutual Funds

There are a few closed end funds that invest primarily in preferred stocks. They usually are leveraged which boost their yield and volatility. Closed end funds have a fixed number of shares and are sold on a stock exchange.

Risks

* Deferral Risk-Traditional preferreds contain provisions that allow an issuer, under certain conditions, to skip (in the case of “noncumulative” preferreds) or defer (in the case of “cumulative” preferreds) dividend payments. Fully taxable or hybrid preferred securities typically contain provisions that allow an issuer, at its discretion, to defer distributions for up to 20 consecutive quarters. If the Fund owns a preferred security that is deferring its distributions, the Fund may be required to report income for tax purposes while it is not receiving any income.
* Redemption Risk-Preferred securities typically contain provisions that allow for redemption in the event of tax or security law changes in addition to call features at the option of the issuer. In the event of redemption, the Fund may not be able to reinvest the proceeds at comparable rates of return.
* Limited Voting Rights-Preferred securities typically do not provide any voting rights, except in cases when dividends are in arrears beyond a certain time period, which varies by issue.
* Subordination-Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure in terms of priority to corporate income and liquidation payments, and therefore will be subject to greater credit risk than those debt instruments.
Liquidity-Preferred securities may be substantially less liquid than many other securities, such as U.S. government securities, corporate debt or common stock.

My investment strategy

Buy a cumulative (or noncumulative of a good company BBB or higher) fixed rate (like 6%) below par value and a call date of several years out. The fixed rate should be a percentage point or two over a 10 year treasury note. This is especially attractive if the interest rate is expected to drop. This will bring in income and if called, a nice capital gains. The downside would be if interest rates spiked up high.

Favorites

Quantum Online - great place for preferreds
Wiki Preferred Stock - more in-depth definitions

Summary

Royalty trusts purchase the rights to royalties from the cash flow and sale of a natural resource company, generally oil or gas. They provide a higher than normal (stocks and bonds) yield. Popular ones are Canadian royalty trusts (canroys) and U.S. royalty trusts (usroys). Each have their advantages.

Pros

Above average income

Royalty trusts generate above average income compared to stocks and bonds.

Depreciation and depletion can be written off

Since the RT is a depreciating asset, a portion of the income is considered a distribution can be written off, i.e. the cost basis is reduced.

Possible tax credit

Some RTs use energy from unconventional resources and may qualify for a fuel tax credit.

Cons

No principal returned at the end of the trust

The original investment is generally never returned at the end of a trust. It is returned as ‘return of capital’ and can be deducted on income tax returns. This is because a RT is a depleting asset that eventually turns into nothing.

Income varies

The income generated varies and is not fixed, like a bond or preferred stock. So a 10% yield may go higher or lower over time. The price of the commodity, generally oil or gas, can vary which impacts the income. Income is usually distributed on a quarterly or monthly basis.

The income is not a dividend

The income generated is not a dividend so it is taxed as such.

Part of the income is considered “return of capital”

Owners are required to file report the pro rata portion of a trust’s total income and expenses on their tax returns. This typically means filing Schedules E and B as well as having additional work with Form 1040.

State income taxes

Owners of trusts are liable for paying income taxes in the states in which the trust generates its royalties. Different states have different thresholds for when taxes have to actually be filed and paid, and the likelihood of owing income tax in multiple states increases with the size of a given ownership position.

U.S. royalty trusts have a finite life

U.S. royalty trusts cannot buy and sell assets (unlike Canadian trusts) thus they have a finite life.

Canadian Royalty Trusts

Canroys are open-ended royalty trusts, meaning they can add assets anytime. Canroy owners pay a 15% foreign tax which is put on the U.S. tax return as a nonrefundable tax credit (i.e reduces your tax payment).

U.S. Royalty Trusts

usroys are closed-end royalty trusts, meaning they have fixed assets. Most usroys are oil and gas related so they are depleting assets and have a finite lifetime.

Details

Look for the expected life left of the trust.

This blog is my holding area for the notes I collect while researching investment ideas.