Investors who are putting money into Royalty Trusts are making a big mistake and the brokers that sell them should be ashamed of themselves. According to Jason Zweig, a noted columnist with the Wall Street Journal (“Will These Royal Yields Rule?” WSJ), these trusts own nothing except income from oil wells and the right to receive it. That income is a depleting asset, just as the oil wells themselves are depleting assets.
Royalty trusts masquerade as high-yield bonds, but investors do not get their principal back at maturity, as they do with bonds: “When there is no money left to pay out, most of the trusts will disappear?and, unlike bonds, they won’t give investors their original principal back at the end,” writes Mr. Zweig.
There are some 30 royalty trusts out there, and many are cutting their income distributions (i.e., the yield). According Mr. Zweig, Hugoton Royalty Trust fell 8% after announcing a dividend payout cut; San Juan Basin Royalty Trust fell 5% after announcing a similar cut; and Dominion Resources Black Warrior Trust fell 6% after announcing a dividend payout cut.
Royalty trusts are being purchased for more money than investors can hope to recover. Mr. Zweig said he reviewed the latest annual report of two such trusts ? BP Prudhoe Bay Royalty Trust and Whiting USA Trust and calculated the present value of the future cash available for distribution as $1.4 billion and $109 million, respectively. However, they are trading at prices that give them (overpriced and unsustainable) market values of $2.3 billion and $123 million, respectively.
Do investors understand that they are often overpaying? “In some cases, they probably don’t,” an official at BNY Mellon, which acts as trustee for 15 of these trusts, including BP Prudhoe Bay Royalty Trust, was quoted as saying, adding: “I wouldn’t argue with that. That’s why it’s so important for investors to review the [financial] filings.”
What reasonable basis could brokers who sell these awful investments possibly have for believing them to be suitable for anyone, let alone a retiree on a modest fixed income?
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.