AVOIDING WALL STREET’S POTHOLES
If you want advice on drawing an income off your portfolio, get it from ex-banker Simon Lack. He knows where to find yield—and also how to dodge brokers’ dirty tricks.
Ex-banker Simon Lack knows where to find yield—and how to dodge brokers’ dirty tricks.
To a producer of investment products, financier Simon Lack looks like a turncoat. He spent years supplying seed capital to hedge funds, then wrote a tattletale book declaring hedge funds to be a rotten deal. He helped a pioneer in energy partnership investing, then declared the fund based on this guy’s work to be a tax disaster. He buys shares of pipeline companies, yet condemns the sector for its “betrayal” of investors.
To a consumer of investment products, though, Lack’s cynical view of Wall Street is rather useful. If you are going to reach for yield, you had better know what pitfalls lie in front of you. This guy has a lot to say about those. His latest book, Wall Street Potholes, is a catalog of bad buys, from nontraded real estate funds to “structured notes” structured to make the brokers rich.
So what does he like? Energy in motion. Via a mutual fund, a recently opened exchange-traded fund and custom portfolios for wealthy savers, Lack oversees $250 million invested in the shares of companies that operate pipelines and other equipment for transporting fossil fuels.
The shares are depressed, making their percent- age payouts very handsome. Tallgrass Energy GP, one of the holdings in Lack’s American Energy Independence ETF, yields 9.1%, five times the stock market average. Targa Resources, another item in the ETF, yields 7.6%. Enterprise Products Partners yields 6.5%.
Portfolio management is a quiescent affair, quite a contrast to Lack’s history in the adrenaline-pumping end of the finance business. Born in Canada and raised by a divorced mother in England, Lack knew early on that he wanted to be a trader. At the Forest School, a very old-fashioned secondary school that he describes as “Hogwarts without the flying broomsticks,” his economics teacher set up a high-speed trading game. Lack beat his classmates. To the anguish of his mother, an editor of financial books, he skipped university to sign up at an institutional brokerage in London. He was 17.
The European economy was too sleepy for his taste. Lack persuaded his employer to transfer him to the New World, where he landed with a girlfriend from high school. They married, they added U.S. passports to their British ones, and Lack jumped to the trading desk at a bank that became part of J.P. Morgan Chase. In time he was overseeing 50 profes-
sionals handling financial derivatives. He also served on a bank screening board that fielded pitches from would-be hedge funds for startup capital.
Come 2009, banks were in distress and Lack, at 46, was ready for a change. He ended his 23-year J.P. Morgan career, cashing out a deferred income account that allowed him to start a new life as money manager and Wall Street critic. The latter role was aimed at making the former more visible. “The day after you leave J.P. Morgan, people forget about you,” he says.
Lack’s first book, The Hedge Fund Mirage, denounced the sector that he had supported as an investment banker. A conflict? Not really. When hedge funds were tiny they captured inefficiencies and beat the market. When they got big, they didn’t do so well. In 2008, he says, hedge funds “lost more money than they had made in the aggregate in all previous years.” Investors would have been collectively better off investing in Treasury bills.
Next, in 2013, came Bonds Are Not Forever, which warned savers away from fixed income. The government had U.S. Treasury holders in a pincer attack, combining inflation with artificially low interest rates. Still good advice, it seems.
Potholes, in 2015, condemned much of what stockbrokers love to sell, like real estate investment trusts that are not publicly traded. The REIT of this genre combines an illusory yield with crushing fees and miserable liquidity. “It’s a nasty, nasty product,” Lack says. “People lost their moral compass.”
Given Lack’s sour take on American finance, it is perhaps not surprising that his bullish view of the energy sector is, shall we say, nuanced. Master limited partnerships that own pipelines are a great buy now for a perverse reason: Some of the people running these outfits are bums.
As conceived three decades ago, MLPs were a terrific deal for retirees in high tax brackets. Pipelines are a toll road in the energy sector, largely indifferent to the price of oil or gas but able to collect a predictable
fee for moving the stuff around. When organized as a partnership rather than as a corporation, a pipeline company would be exempt from income tax itself. Its steady cash from haulage fees would make possible a dividend on which the shareholders would owe scant tax of their own because of depreciation deductions. The growth would be modest but the yield rich.
Fracking changed all that. Pipelines needed capital to reach a plethora of new wells in North Dakota, Pennsylvania and Texas, and they got some by slashing dividends. “MLP investors have been betrayed,” says Lack. “That’s a shame, because older, wealthier investors are the epitome of long term.” Their loss, your gain. Buy an MLP today and you may be buying it at a rock-bottom price from an embittered shareholder who got in when the dividend was higher.
Shareholders in some MLPs were double-crossed in another fashion, when the executives running the show folded partnership assets into corporations in a way that maximized the future tax benefit to the corporations but saddled limited partners with retroactive taxes, at stiff ordinary-income rates, on their past dividends. What’s to protect you from getting taxed in the next corporation reorganization?
Lack has an answer that is at once cynical and practical. In some cases a pipeline involves two publicly traded partnerships: One is a general partner that calls the shots, the other an operating entity that is the bottom dog in the arrangement. Insiders tend to own shares of the general partner, Lack says, and that’s the one to buy, even if it has a lower yield. Insiders won’t reorganize the companies in a way that shortchanges the general partner. Tallgrass is one of those bifurcated pipeliners. American Energy Independence owns the GP, not the operating entity.
Lack’s preoccupation with pipes goes back to 2005. Among the several thousand supplicants appearing before the J.P. Morgan Chase hedge fund committee was Gabriel Hammond, a brash 26-year-old ex-Goldman analyst who wanted money to put into MLPs. Hammond got the dough and Lack the inspiration for the money management firm he was to open in Westfield, New Jersey, five years later.
Hammond went on to found a family of MLP funds sold off to Oppenheimer and to construct a sector index that drives the $10 billion Alerian MLP ETF. Lack’s admiration of this talented entrepreneur doesn’t inhibit his sharp tongue. On his investing blog Lack lambastes the ETF for wasting investors’ money on corporate taxes. He is betting against Alerian in a short sale.
Corporate tax on a fund? This is a phenomenon with which most fund investors are unfamiliar. It turns out that a fund loses its usual exemption from corporate tax when it puts more than 25% of assets in partnerships. As a pure MLP portfolio, the main Alerian fund flunks the test. With pipeline stocks underwater there is no effect at the moment, but as soon as this fund gets to a 6% cumulative return from the May 14 close (from either dividends or appreciation), a 23% tax drag will kick in.
A fund can duck the tax by mixing a 25% allocation to MLPs with a 75% allocation to energy infrastructure companies organized as corporations rather than as partnerships. There are plenty of pipeline corporations to choose from, including firms like Kinder Morgan that hosed limited partners in asset shuffles.
Lack’s ETF is one of those 25/75 funds. It owns corporate Kinder Morgan and Targa along with partnership Tallgrass and Enterprise Products. With $4 million in assets it is a flyspeck next to Alerian MLP, but if and when pipelines emerge from investors’ doghouse, and corporate funds begin to feel the tax bite, American Energy Independence could take some business away from them. Its expenses run to 0.75% of assets annually.