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Is it too late to put your trust in income funds?
00:00 GMT-04:00 Saturday, July 13, 2002
If you're wondering where the beef is in the stock market right now, try income trusts.
We're not just talking about the juiciest returns here. There's actually been a subtle bovine theme in the flood of new trusts coming to market in 2002.
For instance, there's the Keg Royalty Income Fund (KEG.UN-TSX), which began trading this spring and now yields about 10.6 per cent. Burnaby, B.C.-based Keg Restaurants Ltd. runs a national chain of about 80 Keg steakhouses.
Then there's A&W Revenue Royalties Income Fund (AW.UN-TSX), which came to market in February and now yields a tick under 9 per cent. Here, you're buying into the A&W burgers-and-rootbeer chain.
You say you're a vegetarian? In that case, you may be interested in the Sun Gro Horticulture Income Fund (GRO.UN-TSX), a major producer of peat moss for greenhouses and nurseries.
There are so many trusts being issued right now that you have to wonder if the whole sector is overheating. Look at the numbers -- while there were no initial public offerings of trusts in 2000 (everyone loved tech back then), the total in 2001 and 2002 is more than $3.6-billion. If you include the issue of new units by existing trusts, then the total rises to about $8.8-billion.
Investors have been conditioned by events of the past couple of years to expect a reckoning when the markets get ahead of themselves. But what about trusts?
It's hard to generalize here because of all the different types of trusts. Real estate investment trusts, or REITs, mirror the health of the real estate market, while the fortunes of oil and gas royalty trusts are tied in a major way to the price of oil. Then there are business trusts like the Keg and Sun Gro, which are based on the prospects of a particular enterprise.
Still, some type of setback seems almost inevitable.
"At some point over the next 18 months, we'll get a 10- to 12-per-cent decline because someone will cut their payout, or oil drops to $15 per barrel, or there's a big bankruptcy in the REITs, or something like that," said Gavin Graham, vice-president and director of investments at GGOF Guardian Group of Funds.
Guardian runs the biggest income trust mutual fund in Canada, the $1.2-billion GGOF Guardian Monthly High-Income Mutual Fund. Is Mr. Graham concerned about the possibility that an overheated market for trusts could affect one of his company's most successful funds?
Not especially. In fact, Mr. Graham makes a case that trust proliferation is actually good for funds such as Guardian Monthly High-Income, which are an ideal entry into the trust market for small investors.
When trusts first started appearing in big numbers back in the mid-1990s, the choice was mainly limited to REITs and oil and gas royalty trusts. Now, there's the new crop of business trusts, as well as power-generating trusts and pipeline trusts. The diversification benefits here should be obvious to anyone who recalls the 1998 crash of oil and gas trusts when oil prices fell, or the dip in REIT prices following the real estate meltdown around the same time. With so many more trusts to choose from, the vulnerability to a hit for any one sector is limited.
Rising interest rates could also dampen the trust sector, although Mr. Graham points out that REITs have shown surprising resilience at points when rates moved higher.
A more pressing problem in the trust market right now may be unrealistic return expectations.
Mr. Graham alluded to this when talking about the almost 16 per cent a year the Guardian Monthly High-Income has returned on a compound basis over the three years to May 31. A good deal of this surge has come from the rise in the unit price of trusts as they came back from their late 1990s plunge.
Don't expect this to continue, Mr. Graham said.
"You should not expect to buy a trust and get a double, or even a 50-per-cent return," he said. "What you want is the 8 per cent or so that our fund is now yielding."
That 8 per cent is all the more attractive from a tax point of view. While interest from bonds and guaranteed investment certificates is taxed as ordinary income, distributions from trusts are treated more gently. The net result is that the after-tax income produced by trusts is higher than bonds, assuming the same rate of return.
Higher returns usually come with higher risks, and trusts are no exception. Even a trust based on a rock-solid business can cut distributions if conditions deteriorate, whereas a high-grade bond is a virtual certainty.
For sure, there are reasons to be wary of the trust market right now. In particular, there's the trend where companies spin off their less desirable divisions as trusts.
That said, trusts as an asset class are entirely legit. Years from now, most of us will have some in our portfolios, either directly or through funds.
rcarrick@globeandmail.ca
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