Beyond Stocks and Bonds

1. Beyond Stocks and Bonds Master Limited Partnerships High Yield (Junk) Bonds Commodities and Precious Metals Real Estate

2. Master Limited Partnerships What are They?Why Include them in a Portfolio?What are the Disadvantages?What are the Risks?

3. What are MLPs? • Business tax structure created by Congress in 1987 for businesses in the production, processing or transportation of natural resources – oil, coal, gas. • MLPs don’t pay 39.25% tax at the corporate level – distributions passed through to “unit holders” who include them as income. • Have a General Partner and many limited partners – distribution split is important.

4. Types of MLP Businesses • Transportation/storage of oil, gas etc. • Regulated pipelines and storage terminals • Unregulated pipelines • Natural gas gathering, processing, fractionalization • Marine transportation of oil, gas, coal. • Exploration and Production

5. Why Invest in MLPs? • They pay high yields – typically 4% to 8%. • They provide tax advantages - • Typically 80% to 90% of distribution is a “return of capital”, reducing the basis of your investment, and deferring taxes until you sell your units. • If you inherit them and can use the “stepped up basis” you have a significant tax advantage. • Think of them as a substitute for bonds in your portfolio, paying a steady, high yield that provides current income. • Own hard assets, with high barriers to entry and predictable cash flows. • Provide some protection in an inflationary environment. • A good diversifying asset for many portfolios.

6. Return, Risk and Correlation to MLP Index – Jan. 2000 to Dec. 2009 (total returns)

7. What are the Disadvantages? • Your tax return becomes more complicated because most provide a “K-1” form instead of a Div-1099. • Requires different handling on your tax form • In theory you owe state taxes in every state where the company operates – however – • Many states have no state income tax (eg. Texas and Wyoming). • Your income must be “material” eg. above state minimum level. • MLPs are aware of this issue and try to make it as easy as possible • Don’t hold them in an IRA or tax sheltered account – you will counteract some of their tax advantages.

8. What are the Risks? • Cash flows driven more by economic activity, not the price of oil or gas. • Potential changes in tax laws • Look for good cash flow coverage ratios. • Highly levered and sensitive to interest rates changes and functioning credit markets. • Many use short term credit market and “roll over” debt frequently. • Severe declines in 2008 because credit markets “froze”.

9. High Yield Bonds

10. High Yield Bonds • Typically corporate bonds with credit ratings of BB or lower. • Pay higher yields than investment grade bonds • Use sparingly in a well diversified portfolio of assets to increase return. • Default risk will be a function of the health of the economy. • Look to buy when spread between high yield bonds and treasury bonds is larger than average. • Use mutual funds or ETFs, don’t buy a few individual bonds.

11. When is a Good Time to Buy High Yield Bonds?

12. Commodities and Precious Metals

13. Commodities and Precious Metals • Basic products – Demand and supply driven by economic activity, weather, natural disasters - • Agricultural products – wheat, corn, coffee, cattle, etc. • Metals – copper, aluminum, etc. • Energy – oil, gas • Precious metals – demand driven by the value of currencies • Gold and silver – reflect the value of the dollar

14. Investing in Commodities • Direct investment by individuals is difficult • Best to use a mutual fund or Exchange Traded Fund. • Requires expertise for direct investment • Advantages and Risks • Can provide “equity like” returns with low correlation with stocks and other assets • Inflation hedge • May involve higher management fees • Some suggest a small allocation (2%-5%) to gold or silver • Should you use physical asset, ETF, or equities?

15. Real Estate

16. Types of Real Estate Investments • Direct investment in real property – apartments, rentals, land, commercial property. • REITS – shares in a companies that invest or finance real estate assets – can be equity, mortgage or hybrid REITS. • REITs oftertax advantage – income not taxed at company level if 90% of income is distributed to shareholders. • However, some of distribution may be taxed as ordinary income, not at the favorable dividend tax rate. • Often use high leverage and returns can be volatile • Declined dramatically (-50%) in early 2009 but recovered significantly in 2009-2010.

17. Real Estate Advantages and Risks • Returns typical lie between stocks and bonds • Compare REITS to investing in high yielding stocks or high yield (junk) bonds • Diversification benefits • Bond like cash flows but values driven by other factors than interest rates • Inflation protection • Often illiquid • Good management is essential • Be wary of high management fees, leverage and location of properties

18. Investment Management Companies Mutual Funds Exchange Traded Funds

19. What are Mutual Funds? • A registered investment company that pools funds from investors to make investments • Open end (the majority of mutual funds) – stands ready to buy and sell shares in itself to investors, at any time. • Closed end - issues a fixed number of shares that are then bought and sold by investors, only in the open market. • You probably can find a mutual fund that invests in any type asset you seek. • Value per share is calculated at end of each day – called “net asset value” (NAV)

20. Mutual Fund Costs and Fees Sales charges or “loads” Front-end loads are charges levied on purchases. Back-end loads are charges levied on redemptions. 12b-1 fees. Funds may spend up to 1% of fund assets annually to cover distribution and marketing costs. Management fees (stated as a % of assets) Usually range from 0.25% to 1.00% of the funds total assets each year. Are usually based on fund size and/or performance. Trading costs Not reported directly Funds must report "turnover," which is related to the amount of trading. The higher the turnover, the more trading has occurred in the fund. The more trading, the higher the trading costs.

21. Reasons to Invest in Mutual Funds • Provides instant diversification • Provides professional investment management • Provides various shareholder services • NOT in anticipation the mutual fund will outperform the appropriate market index over an extended period.

22. Things to consider when choosing a mutual fund • Total costs and fees you will pay. • No correlation has been found between fees charged and performance. • Fund Objective • Does it provide the asset exposure you are seeking? • Stability of Fund Management • Who makes the investment decision? • How liquid is your investment?

23. Exchange Traded Funds - ETFs • Look like a mutual fund with some important differences- • Most ETFs are not managed to outperform but designed to replicate an index – original ETF was the SPDR, which tracks the S&P 500 index. • Their shares trade continuously throughout the day and are held in a brokerage account like any other share of stock. • You can treat ETF shares like any stock to short, hedge with options, margin, etc. • Newer ETFs offer leverage exposure to up or down markets. • With commodity ETFs, find out what asset the fund holds – eg. gold futures or physical gold.

24. ETFs Costs and Fees • Trading costs – • you pay brokerage fee to buy/sell ETF shares in your account while • you buy mutual funds directly from issuer. • Management fees – • Generally lower in an ETF than mutual fund • An S&P 500 ETF is 7 to 10 bps* while a low cost mutual fund is 18 to 24 bps. • Performance – • If your want to mimic an index (say Russell 2000 small cap index) make sure your fund tracks index well, measure by the tracking error. *bps is “basis points”. 1.00% is 100 bps.

25. Should you buy an ETF or a Mutual Fund? • If you seek index exposure, then either can be used. • If you trade frequently, then the mutual fund will probably be least costly. • If you buy and hold a position, then the ETF may be least costly since you are paying a lower yearly management fee. • If you want to include the asset in your brokerage account and treat it like any other stock, the ETF is superior. • When using a specialty ETF understand the leverage it uses and its performance to the benchmark.

26. Useful Internet Sites www.ici.org (mutual fund facts and figures) www.vanguard.com (example of a major fund family website) www.fidelity.com (website of largest investment advisory firm in US) www.mfea.com (information on thousands of funds) www.morningstar.com (one of the best mutual fund sites) www.domini.com(more “social conscience” funds) www.vicefund.com (“vice” funds) www.ishares.com (more on exchange traded funds) www.ipathetn.com (all about ETNs) www.hedgeworld.com(hedge fund information) www.hedgefundcenter.com(more hedge fund information)