The four ETNs which presently pay dividends are Claymore CEF Index Linked Goldman Sachs Connect ETN (GCE), BearLinx Alerian MLP Select Index ETN (BSR), Barclays Asian and Gulf Currency Revaluation Note (PGD), and Barclays GEMS Index ETN (JEM).
GCE invests in a basket of 75 discounted Closed-End Funds following a CEF index selected by Claymore Securities (www.claymoresecurities.com). GCE’s distribution rate is variable. The past three quarterly dividends were $1.66, $0.28 and $0.64.
BSR is an energy infrastructure play which invests in fifty Master Limited Partnerships (MLPs) that track the “Alerian MLP Select Index.” One unique feature of this ETN is its issuance of a 1099 at year-end rather than the K-1 Partnership tax report normally associated with individual MLP holdings.
PGD and JEM are both currency bundles which are pegged, to some extent, to the US dollar. PGD includes currencies of the Saudi Arabian Riyal, Hong Kong dollar, United Arab Emirates Dirham, Singapore dollar and the Chinese yuan. The JEM bundle includes currency holdings from 15 Global Emerging Markets in Eastern Europe, the Middle East, Africa, Latin America and Asia.
PGD and JEM both distribute interest earned on the local currency deposits in the form of monthly dividends. Of these two currency bundles, income-oriented investors have been purchasing JEM for its 7% plus dividend payout. PGD has only a nominal 1% dividend and is more of a currency bet than an income strategy.
JEM not only pays a great monthly dividend, but it appears to be exceptionally wellconstructed as a currency bundle. There is substantial geographical diversification within its 15 specific countries selection spread across Asia, Latin America (although Argentina seems somewhat suspect), Eastern Europe, the Middle East and Africa. The specific currencies in the JEM bundle are the Hungarian Forint, Polish Zloty, Russian Ruble, South African Rand, Turkish Lira, Argentinean Peso, Brazilian Real, Chilean Peso, Columbian Peso, Mexican Peso, Indian Rupee, Indonesian Rupiah, Phillipine Islands Peso, South Korean Won and the Thai Baht.
Given the US dollar’s recent appreciation, currencies not pegged to the dollar will tend to depreciate. Fortunately for JEM holders, most of its currencies are either tightly, or at least loosely, pegged to the US dollar. Devaluation of any one or more of JEM’s currencies is perhaps a greater risk. When defending against potential devaluation, if a country’s central bank holds a large reserve of US dollars (or a growing balance of payments surplus that is building up its dollar reserves), it generally will have the US dollars necessary to bid its currency back up in value.
Ray Hendon, a currency expert in California (see “Carrying the Dollar Upstream”), points out four specific strengths of the 15 countries represented by JEM:
- They have a wide geographic diversity.
- Nine out of the fifteen countries have an current account surplus as a result of being commodity exporters versus importers.
- The macro economic strength of the EM countries is strong in terms of GDP growth and US dollar reserves.
- The fifteen countries have a wide spectrum of interest rates ranging from Korea at around 3% to Turkey at 18%.
(For more information on Currency ETFs and Currency ETNs, see Mr. Hendon’s excellent article “Is There a Role for Foreign Currency ETFs in Your Portfolio?”).
Yielding more than 6%, BearLinx Alerian MLP Select ETN (BSR) tracks the performance of the Alerian MLP Select Index and provides investors a wide exposure to energy infrastructure securities via MLPs (Master Limited Partnerships). Holding 50 different MLP constituents, the Alerian MLP Select Index measures composite performance as calculated by Standard and Poor’s float-adjusted, market capitalization-weighted methodology.
As a brief background, Master Limited Partnerships have traded on the New York Stock Exchange since their creation by the Congressional Act of 1986. Infrastructure MLPs own and operate long-lived, high-value physical assets that engage in the transportation and storage of natural resources such as refined petroleum products and natural gas. This emerging asset class represents $140 billion of public market capitalization. Driven by toll-road business models, significant barriers to entry and attractive organic investment growth, these specialized MLPs have returned an impressive 18% per annum for the past eleven years.
There are three advantages of owning BSR compared to buying single MLPs:
- Investors do not receive K-1 Tax Forms, but instead get a Form 1099.
- No state tax filings are required.
- Investors receive significant diversification across the energy infrastructure and MLP space in a single security.
While BSR trades like an equity on the NYSE, and is similar to investing in an ETF, Exchange-Traded Funds are prohibited from investing more than 25% of their assets in Master Limited Partnerships without paying entity-level income taxes. Because BSR is not a registered investment company, as an ETN, it provides the same level of liquidity and transparency to investors as a typical ETF, but is a more efficient structure to hold MLPs (an ETN is not subject to the “double taxation” inherent in typical corporate structures investing in MLPs).
As with any asset class, shrewd timing is of the essence. According to an excellent article in the September 2008 edition of the highly-respected “The 12% Letter” (Stansberry & Associates Investment Research), this is an excellent time to buy energy infrastructure investments. “The 12% Letter” points out that profits are booming in the pipeline industry, and investor yields currently range from 6% to 8%. But, despite this, energy infrastructure MLPs are down some 23% from their peak just a month ago. The article further points out that anytime yield spreads between pipeline MLPs, and Treasury Bonds exceed 3%, it’s time to back up the truck (”The 12% Letter” says yield spreads are now over 4% and the last time this happened back in July 2002, pipelines rallied more than 80% over the ensuing 28 months). No one knows the potential for BSR, of course, but if the editors of “The 12% Letter” are only partially right, maybe you should consider adding this specialized ETN to your income portfolio.
Perhaps the most intriguing of the income ETNs is the little known Claymore CEF GS Connect ETN (GCE) which tracks the Claymore CEF Index. The Index is 100% rules-based and tracks the performance of a weighted basket of 75 Closed-End Funds carefully selected for their high liquidity, above average income distributions and deep discounts to Net Asset Value. The Index follows a modified liquidity weighting methodology developed by Claymore Securities, Inc. This index portfolio of CEFs is reconstituted and rebalanced every 367 days.
GCE’s current distribution rate is approximately 7.5%, and dividends are paid quarterly. Most notably, the current discount to NAV of the 75 Closed-End Funds in the Index now exceeds 10%, one of the greatest discounts to Net Asset Value in years. GCE’s asset class weighting is 35% US Equiity, 30% Global/International Equity, 32% US Fixed Income & Cash and 3% International Fixed Income.
In addition to its excellent yield and historically high discount, GCE’s underlying rules-based selection process is innovative, thorough and exceptionally well-conceived by Claymore. Claymore first screens all 700+ CEFs to weed out any funds that:
- Do not trade on US exchanges
- Generate non-taxable income by investing at least 50% of their assets in non-taxable securities
- Are interval funds
- Have less than six months of operating history
- Have market capitalizations of less than $250 million
- Have a market share price less than $5.00
- Have a trading volume of less than 1 million shares in each of the six months preceding reconstitution of the Index
- Are not organized in the United States of America
After excluding these funds, the remaining CEFs are ranked using a matrix based on discount (90% weighting) and distribution yield (20% weighting). The top-ranked 75 Closed-End Funds are then included in the Index. The next rebalancing will occur in March, 2009.
The Index is down about 6% year to date versus the S&P 500 loss of approximately 11%. The hypothetical annual performance of the Index from March 5, 2002 through June 30, 2008 is 11.23% versus the S&P 500 4.21%.
So…yes, Virginia, there are several high dividend ETNs. They represent unique alternative asset classes; Currencies, Master Limited Partnerships and Closed-End Funds. Their dividend distribution rates are excellent, and the timing for each seems attractive. Check them out, you may be pleasantly surprised by these dividend-paying stealth ETNs. We were!
Disclosure: none
This article has 17 comments:
Normally, high-yield implies high risk. I suspect that is the case here as well.
Best wishes,
Ray
1. The hazard is the possibility of accumulating > $1000 of Unrelated Business Taxable Income (Item 20, code V on the K-1) which requires the tax shelter's FIDUCIARY to file an income tax payment via form 920t to the IRS. You can't pay the tax directly as the IRA beneficial holder because:
1.- the K-1 comes after 1099's are filed, usually in Mid February, but as late as March 30th...after the end of the tax year for the sheltered account. It also comes from the partnerhip's bank or record-processor, and not from your IRA account's fiduciary. So it can cost a lot to have your IRA fiduciary file the tax forms.
2.- You can't pay the tax yourself, because that would be a delayed and forbidden excess contribution to the sheltered account. The tax must be paid from the IRA account.
3.- And the tax may be tiny, but the filing costs, charged by the fiduciary...the brokerage or fund company that holds your IRA accounts... may be expensive.
b- All of the partnership's return of capital and carry-forwards of capital investment losses are lost in a sheltered account...{the only tax that you pay is when you take a distribution from the sheltered account and pay at marginal rates, and so, you gain no benefits from the increase in basis (which decreases the net capital gain on sale)...etc., that would accrue in a taxable account where short-term dividends are slowly converted to long-term gains from the division of dividends to both current income and return of capital, etc, are LOST in sheltered acccounts.
c- The K-1s are filed electronically, they have the IRA or Account # on them, and any amount over $1K from one - or accumulated across several shelters ( S-Corp., SEP, IRA, Roth, etc.) for one taxpayer, may render all the accounts taxable.
In addition, other types of commodity-holding ETFs (but the Treasury hasn't yet ruled on ETN's which it taxes as though they were "bonds", because it considers them debt-instruments)(not futures -trading) : Commodities are not permittted in any IRA; the exception is made for U.S. minted coins. GLD, SLV and others that hold commodities aren't legal in an IRA.
Unrelated Business Taxable Income may come from sales of assets by a partnership, at a profit, when its tax-shelter registration states that is in the "leasing" business... just as an example. At the partnership level, the income is from business that is not related to the activities listed for its registration.
So there is the possibility that ETN's that hold commodities may be exempt, but since it took the Treasury until last fall to figure out how to classify ETN's for any tax (which was some years after they began)...I don't have a clue whether they will be "legal" in a tax-sheltered environment.
In short...if it files a K-1, you will benefit most in a Taxable account.
Commodities are not permitted in a tax-sheltered account.
I'm not familiar with USO (an Oil ETF), and I believe that you can get the info at the market maker's investor relations site. Each ETF has a site for "investor relations' with a toll-free number to call and get this info.
The question of the ETN's is quite diferent, because they are considered "debt instruments" by the IRS...they are literally promises to pay by an investment bank. I don't think that the securities are a commodity, any more than the currency ETN's are "foreign currency" which also can't be in a sheltered account.
As far as tax-shelter substitutes for DBA, try MOO; for GLD try a gold-miner or silver miner ETF; for shorting, I'd try the Rydex funds, which aren't holders of commodities...for a tax-sheltered account, they have inverse and double inverse funds.
It's not the prohibition about lending or borrowing that's at issue regarding short positions in an IRA that I'm referring to...but rather the limitation on the physical holding of commodities that will cause disqualification.
No matter how long you've held the ETF that files a K-1...a week or 6 mos, or longer...you will receive a K-1 from DBA or DBC. But they have bigger advantages in a taxable account than in a sheltered account. This is also true for "Holdrs" from ML, and Grantor Trusts.
One problem with domestic royalty trusts is that sometimes the states where they are headquartered do send a tax bill...and if your state has a "reciprocity" arrangement...the bill can morph into a lien against your sheltered account...and clearing this up can be a big pain in the ... California and Arizona are notorious for this, because the states aren't permitted to tax the proceeds in an IRA, but they'll try anyway.
I'm not a tax-expert, but many of these problems can be avoided by visiting the market makers site and looking at the Tax-Info, and if you're not clear about the liability, call them, before you purchase securities for a sheltered account.
When you file the regular taxable 1040, the K-1 info in the taxable account is easily handled by the mid-tier tax prep software...the items go into the proper places on the worksheets for the Schedules A, B and D, and even the tax-shelter Registration Number -which must be filed for the taxable accounts - is properly filled in for you. So it's not so tedious or intimidating as some have written - even for taxable holdings. But you should delay filing until the 10th of April, to be sure that all the tardy K-1's have been received (they must be sent out before March 30, by the business' compliance office).
I'm surprised to learn from d_teller that the less than $1k unrelated business taxable income is summed across your different tax sheltered accounts. Are you sure? They have different account numbers and some are with different brokerages -- are they added up by my ssn? I thought each account had its own $1k limit for UBTI. Now I have to go back and redo my math, I'm not in the clear by as much as I thought I was. Eeeek! this would be a disaster! Good thing these are recent additions and I probably still have a total less than $1k.
Yes, the below statement from KMP suggests that all or nearly all of their distributions will be UBTI.
Employee benefit plans and most other organizations exempt from federal income tax, including individual retirement accounts and other retirement plans, are subject to federal income tax on unrelated business taxable income. Virtually all of our income allocated to a common unitholder which is a tax-exempt organization will be unrelated business taxable income...
And as User 232593 aptly points out ( AboutETFs.com is in complete agreement) never, NEVER buy an individual MLP in your qualified retirement plan. While not a "prohibited transaction" per se, the risk of your custodian having to report "Unrelated Business Taxable Income" (UBTI) from certain MLPs just isn't worth it. Admittedly this risk is quite remote unless you hold particularly large blocks of individual MLPs which might generate more than $1000 per MLP annually. But we still advise you to just say NO!
Despite our negativism toward holding individual MLPs in your tax qualified plans, there ARE at least five securities which invest in Master Limited Partnerships which are perfectly fine to hold in your IRAs and other retirement accounts. These five holdings are structured as Type C Corporations and issue 1099s, not K-1s (even though each invests in MLPs.) By not issuing K-1s, these five different investments provide a secure way to enjoy the benefits which MLPs offer (mainly high distributions ranging from 6.1% to 8.4% per year) without the taxation confusion.
Four of these MLP asset plays are Closed End Funds and one is BSR, the Exchange Traded Note (ETN) which we featured in the above article. The four CEFs are FMO (Fiduciary/Claymore MLP Opportunity Fund- www.claymore.com), SRV (Cushing MLP Total Return Fund- www.swankcapital.com), KYN (Kayne Anderson MLP Investment Company- www.kaynecapital.com) and MTP (MLP & Strategic Equity Fund- www.iqiafunds.com).
Here are the current Distribution Rates and Premium or Discount for each CEF: FMO- 7.0% Dist, 7.75% Premium; SRV-7.5% Dist, 11.6% Premium; KYN- 7.3% Dist, 6.5% Premium; MTP- 8.46% Dist, 1.7% Discount. We would be sellers of FMO, SRV and KYN due to their Premiums to NAV. We would be buyers of BSR which generally trades at parity with its underlying Index and MTP for its slight Discount to NAV and its 8.4% Distribution Rate.
So here's how they stack up: JEM- all Currency Yield plays with no direct exposure; BSR- all Energy Infrastructure Master Limited Partnerships with no direct exposure; GCE, on the other hand, DOES have moderate exposure. GCE holds 75 Closed End Funds, with each of individual CEFs having as little as zero exposure all the way up to as much as 100% exposure. Only two of its holdings have 100% exposure. The average exposure that GCE has to the troubled industries that you mentioned, David, (Financial, Housing, Banking and Junk Bonds) is currently 20.5%. We rate this risk as quite moderate considering the excellent diversification of this ETN, its current 7.5% Distribution Rate and its historically high 10%+ Discount to NAV (this large discount probably indicates that investor fears about the financials in the portfolio are already baked into the price).
We suspect that a basket of these three ETNs is not nearly as risky as you fear....time will tell.. Good luck and thanks again for your excellent question.
Thank you for redirecting my attention to the 1099-filers.
The reason I get carried away on the subjects of commodities and UBTI, is because there are a lot of people who hold these grenades in sheltered accounts.
And as an example: {and also to the commenter "onetaste", and to your statement about accumulating >1k from large blocks of MLP's/ account) the UBTI limitation is per taxpayer I.D., not per account.
The IRS gets the account #'s on the K-1 forms, and it tabulates all the sections and codes PER TAXPAYER NUMBER.
If a CanRoy converts to a MLP, a lot of people will have all their shelters placed at tax-hazard, unless they periodically check the SEC applications for conversion: PGH is one CanRoy that had, early this year, filed to convert to an MLP.
Again, many thanks for the MLP's in chapter C format; If one holds a few MLP's in several sheltered accounts, the sum of $ assigned to Section 20, Code V on all the K-1's can easily exceed the UBTI limit.
And then, one has to arrange for one's fiduciary (ies) to file the Federal Income Taxes from the sheltered accounts, in order to keep the tax-shelters intact. That can be a real costly pain in the ...
All the more reason to stick with only securities wrapped inside C Corporations, a structure which issues a Form 1099, not a K-1.
Also a great heads-up about CanRoys (Canadian Royalty Trusts) which might convert to MLP status.
d_teller: Do you know of any service, newsletter, etc which might report on pending conversions to MLPs? Thank you again for your detailed discussion and clarification on these complex tax issues. Call me sometime..I'd like to pick your brain on a couple of other issues.
Thanks. (1-877-260-0800 toll-free). Chance Carson, Editor, AboutETFs.com (www.AboutETFs.com)