2003.01 Brought to you by : René Després, Financial Planner
Autonomous Partner to Le Groupe Langevin
Affiliated with AEGON.
With the kind cooperation of Talvest Mutual. Funds
2003.01 Brought to you by : René Després,
Financial Planner
Autonomous Partner to
Le Groupe Langevin
Affiliated with AEGON.
With the kind cooperation of Talvest Mutual. Funds
Income trusts: A viable asset class for now and the long termAs stock markets falter, income trusts have been one of the few bright spots on the investment horizon over the past couple of years. Falling somewhere between stocks and bonds in terms of risk, trusts have generated strong yields in an economy characterized by historically low interest rates.
Income trusts are essentially a type of business structure. Instead of issuing shares, a company sets up a public trust. All of the trust’s cash flow is distributed to investors, after expenses. For corporations that tend to generate a lot of cash, it’s a convenient and economical way to raise capital in a business environment where demand for share offerings has dried up.
For conservative investors, it’s a chance to gain a steady flow of income at yields that are currently easily outperforming traditional debt instruments, such as bonds. Trusts may also be a good fit for more aggressive investors looking to shore up their portfolio in the face of weak performance on the equity markets.
Trusts are an equity-based investment similar to mutual funds. They are professionally managed and sold as units, but unlike mutual funds, trusts trade on the stock markets. The main difference between stocks and trusts is the ultimate aim of the investments. While stocks focus on capital appreciation, trusts are geared to income generation.
Royalty Trusts focused on the energy sectors and first came to prominence in the mid 1990s. In 1994, there were just five royalty and income trust issues, within a market cap of $2 billion, according to Morrison Williams Investment Management, based in Toronto.
Today, there are 91 royalty and income trusts in Canada, broken down into four main categories: utilities and pipelines, oil and gas, real estate, and industrial. Trusts now have a market capitalization of around $34.5, a figure that could rise to at least $50 billion by 2007, says Morrison Williams Investment Management.
Although low interest rates have been the driving force behind the growth of the trust sector, the three-year long bear market has also dragged down stock yields. Rising energy prices are also a factor, as is basic supply and demand.
Investors want a product that will generate a good level of cash flow and corporations looking to raise capital can’t help but notice the hot income trust market. That alone creates an incentive for businesses to spin off some assets into trusts, analysts say.
Of course, when a sector rises, there’s always concern that the bubble will burst. The recent “tech wreck” is still fresh in investors’ mind. And income trusts suffered their own “dark period” in the late 1990s when energy prices were weak and interest rates were rising. So are we heading for an income and royalty trust crash? It’s possible, but most experts don’t think so. “They are essentially high yield equities, so there's definitely some risk, but I'm not sure that I would really expect a bust,” says Dan Hallett, senior investment analyst at Sterling Mutuals in Windsor, Ontario “Some of the trusts are just getting back to prices they reached in 1996 and 1997.”
As well, the income trust environment has changed over the last few years evolving from a sector that was dominated by volatile cyclicals, such as energy trusts, to today, where there’s a larger component of mature, stable businesses.
Still, with interest rates expected to rise in 2003, trusts could become less attractive. And as the number of trusts balloons, there’s a risk a few may fail, creating a backlash for the entire sector.
As with any investment, it’s important for advisors, and investors, to do their homework and take a close look at the quality of the underlying business. “Some trusts are more well managed than others, and generate a more stable cash flow,” says Hallett. “If the business is sound, the yields will grow.”
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