Even in a time of rising rates, utility stocks have their place in a portfolio, as a form of diversi...
Income Opportunities Beyond the Cliff
01/11/2013 11:20 am EST
There was a lot of handwringing about the horrors that awaited investors-especially income investors-once the fiscal cliff deal was done but relatively little has occurred and it has clarified some great opportunities says, Neil George, Jr., of By George.
Gregg Early: I'm here with Neil George, editor of By George, and also associate editor at Liberty Investor. Neil, up until recently there has been quite a stir over the fiscal cliff and people were issuing special dividends and all sorts of stuff because the world was effectively going to come to an end, but it seems like we've carried on and the Mayans were wrong and the doomsayers on the fiscal cliff were wrong. Where are the opportunities now?
Neil George: I guess a key thing to look at is people were very fearful of the what-ifs that were going to be occurring in the tax code, and the idea of looking at a call to raise revenues in a very quick, massive way really had a lot of people spooked in the investment community, and corporations and so forth trying to payout special dividends to get cash out the door at effectively lower tax rates.
The reality is that yes, we have ended up getting higher tax rates on income. We already were faced with the excise tax coming out of the Obamacare for the wealthy, and now we've seen raises in dividends for both qualified dividends.
Then for those in the upper reaches of income you've also seen a bump up in ordinary income rates, but what we haven't seen is any increase in corporate tax rates and we also haven't seen any changes to some of the tax advantaged parts of the marketplace. So the end result is that for those that are facing concerns over paying higher tax rates because of the Obamacare surtax as well as the changes in dividends and gains rates, the idea of focusing on investments that are tax advantaged, those are the ones that were doing well prior to this change, but there were concerns that they might lose their tax status. Now since they haven't we're starting to see this particular sector continuing to perform extremely well.
Gregg Early: Is there any threat to these because now they say the fiscal cliff is over, but we have to worry about the debt ceiling? Is there a threat that moving forward will any of the debt ceiling debates become just like the fiscal cliff concerns previous to them for these securities?
Neil George: Well I think you're right; there are going to be some concerns. But I think those that look at how the resolution was done for the fiscal cliff, it really didn't do much as far as revenue. The Congressional Budget Office actually said that really the net effect of the tax code effectively means we're really only looking at about $15 billion more in tax revenue, as opposed to some of what was initially potentially going to be happening.
Now going forward, looking at politicos, we're not seeing any sort of summit for really going after a couple of core groups that are very integral to the US economy and to the marketplace. One area particularly, the municipal bond market. There were many that were talking about limiting the deductibility, maybe eliminating the deductibility of muni income.
It was explained to Congress, as well as to the White House that doing that would have a significant negative effect on net federal revenues and would be very chilling to a lot of municipalities and states that have been improving their stature, just at the wrong time. Therefore, muni bonds, which have been one of the strongest performing sectors over the past few years, as well as the past decade, are continuing to do well.
The idea that they're going to look to start taxing munis has been set aside, I think, on a sustained basis, and therefore investors might want to start looking at buying three of my favorite closed-end muni bond funds; one is the AllianceBernstein (AFB). The other one is Nuveen Quality Income (NQU). The last one is run by BlackRock. It's the BlackRock Muni Income (BLE).
These collectively average about 5% plus yield, which is obviously federally tax advantaged, and you have been capitalizing a lot of movement into the muni market and therefore will be having some fairly good, steady gains. The result is then for the past year returns have been in the upper teens collectively for these, and if you look at the track record for the last decade you're seeing basically double digits returns year after year. Much of that is effectively tax advantaged and therefore keeps income going, get some gains, and avoid paying some additional tax.
The other area to look at would be some of the pass through securities such as master limited partnerships (MLPs), limited liability corporations (LLCs), and so forth that do not have to deal with corporate tax. Also their distributions are largely tax sheltered because of depreciation on their underlying assets.
In this area, again, there was talk that they might want to start taxing these, but again, that would curtail some of the crucial infrastructure and crucial energy markets that have been responsible for a lot of job and economic growth for the past several years.
A few different examples in three different groups; one in the oil and gas sector, an ongoing favorite of mine, Gregg, has been Linn Energy (LINE). It's paying about 7%. Most of that is sheltered so you're not going to have any tax liability on a current basis.
Another in the pipeline business, which has been getting a lot of further development, Enterprise Products (EPD) has been a favorite of mine for many years. It's paying a bit less at 5% but it has been a very strong, consistent performer for many years, and again much of that is sheltered from current tax liability.
Lastly, a favorite came to the marketplace in the 1990s, a company, which is in the commercial real estate sector. They do sale lease backs; they acquire companies, headquarters, distribution centers from major companies in the US and elsewhere and they lease them back to those same companies. It's a very stable and secure business-W.P. Carey (WPC).
Again, about 5% plus yield but if you look at the performance for the last many, many years since they came to the public market, they consistently turn in very significant performance. Much of that income ends up being sheltered from even the higher tax liability that a lot of individuals are facing right now.
Gregg Early: So it sounds like now that at least there's some clarity. What's the great quote-"what the market hates the most is uncertainty"-but now that the uncertainty has cleared to a certain extent and it seems like there is a great amount of opportunity out there.
Neil George: Yes, and I think the idea of people looking at what their tax liability is going to be, seeing what the rates are doing, and then understanding the thought process, what has already happened, that discounts the possibility of seeing a dramatic tax change affecting the muni market, or looking at the very low to nil possibility of starting to change the tax code that would impact pass through securities.
These sectors now generate tax advantaged income that still can provide good dividend flows for an individual investor, and at the same time that individual investor will have less current tax liability by owning these sorts of investments. You can still get a good income and basically avoid having to pay some of the new more onerous tax rates.
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