|I copied this from an Ivillage message board.|
The Little-Known Asset Class Boosting Yields +151% in a Year
These special securities were designed for one sole purpose -- to provide investors with a steady stream of rising income. We're not talking about some fantasy investment idea. We're talking about a little known and often misunderstood group of securities called "General Partners" -- or "GPs" for short.
Only a few years ago, you couldn't invest in these money-making machines since they were the exclusive preserve of private equity firms and other insiders. But in the past three years, some GPs have started trading publicly in a bid to raise the capital needed to build the nation's energy infrastructure. Although the doors are now open to the public, many investors are not yet aware of the tremendous income potential of these distribution growth dynamos.
You've likely heard of master limited partnerships (MLPs), a group of about 100 securities -- mostly pipeline companies -- that boast double-digit yields and double-digit dividend growth. "Dividend Optimizer" holding Magellan Midstream Partners (NYSE: MMP), for example, is a premier MLP that operates the longest refined petroleum products pipeline in the nation.
But you may not be familiar with the groups behind these MLPs, the people that really run the show -- the general partner (or more accurately, the company that owns the general partner). Until recently, GPs offered dividend yields of about 4-5%. But now that has changed, and the average yield of the nine strongest and highest-yielding GPs we've identified today is a solid 10.8%. That's right, the yield for this group has risen +151% between 2007 and 2008, as you can see from the accompanying chart.
As you know, yields rise as prices fall, but lower share prices are not the sole reason for the higher yields of these GPs. It may seem hard to believe in today's markets, when dividend stalwarts like Bank of America (NYSE: BAC) and Citigroup (NYSE: C) have slashed payouts, but the GPs we've selected have seen their dividends (called "distributions" in partnership lingo) grow an average of +14.0% during 2008.
How GPs Make Money
What's behind this growth amid one of the worst years on record for dividends? It's called "incentive distribution rights" (IDRs). Don't let the legal sounding jargon fool you into thinking that these rights are worthless mumbo jumbo. In fact, they're the money-making catalyst for the general partners and the investors who own a stake in these GPs.
Here's how the system works. General partners manage the day-to-day business of master limited partnerships. The MLPs such as Magellan Midstream Partners are like silent partners. They receive cash flow from the pipeline assets, but aren't involved in running the business.
That's the job of a company like Magellan Midstream Holdings (NYSE: MGG), which owns and controls Magellan GP. MGG, for instance, identifies potential acquisitions, arranges financing, oversees operations, and even sets dividend policy. GPs also may help fund growth by providing capital, loans, or other financing.
In return, GPs are amply rewarded for their efforts. They typically own a 2% equity stake in the MLP, but that's not all. They also receive a special management fee in the form of incentive distribution rights. These additional distributions are legally binding. They're paid out according to a pre-set formula that's given in the prospectus when the MLP is formed.
Exponential Distribution Growth
MLPs must pay out almost all their available cash each quarter to partners, including the general partner. Most general partners are also organized as partnerships or limited liability companies, so they must also distribute the bulk of their cash flow to unitholders.
Typically, the GP receives an initial 2% of the MLP's distributable cash flow to reflect its 2% equity interest, while MLP unitholders get the remaining 98%. As the limited partner's distributions increase, however, the percentage take of the GP also increases, often to a maximum of 50%.
For example, MGG's distribution rights, together with the 2% equity interest, look like this: (chart did not post and the rest of the article was to long to show up here.)
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