Will These Royal Yields Rule? – By Jason Zweig

Investors reaching for yield should always bear in mind the warning label on stepladders: "DANGER. DO NOT STAND ON TOP STEP."

Just look at what happened this past week to investors in several so-called royalty trusts. These instruments, which collect and distribute income from oil and gas or mining properties, are among the highest-yielding in the stock market, with payouts averaging 9%.

But last Wednesday, the "unit," or share, price of Hugoton Royalty Trust fell 8% after it announced a cut in its dividend; on Tuesday, San Juan Basin Royalty Trust also cut it payout, knocking its shares down 5%. And Dominion Resources Black Warrior Trust fell 6% this past week after it declared a dividend cut the previous Friday.

Many people—especially older, conservative investors hoping to rejuvenate their shriveled bond portfolios—might not realize what they are buying when they invest in these rare, peculiar and suddenly popular instruments.

There are some 30 royalty trusts, with a combined market value of roughly $12 billion; at least seven have sold their shares to the public for the first time in the past year.

By design, they have no employees or physical assets, and most will cease to exist in 20 years or less. Their only value consists in the income they distribute. But their future payouts may well be a ghost of the yields that appear so attractive to today's investors.

Why are the yields on royalty trusts all but doomed to dwindle?

Unlike the more-familiar master limited partnerships, which often own or operate energy, mining or other assets, the typical royalty trust holds only the right to receive income from a fixed number of properties.

Once the trusts are set up, they are frozen and can't acquire any new interests to replenish their stream of income.

When their share prices are cheap, as many were in early 2009, royalty trusts can be a great investment.

But timing is everything, and many of these trusts are far from bargains today. Wells and mines tend to become depleted with each passing year, making a decline in yield almost inevitable unless commodity prices boom.

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.