Like termites, income trusts have bored their way into everything from the country's premier stock index to the mutual funds in your portfolio.
Trusts began taking their place in the S&P/TSX composite index yesterday alongside the likes of Royal Bank of Canada, Manulife Financial Corp., EnCana Corp. and Canadian National Railway Co. This is a milestone for a sector that was basically invisible five years ago, but let's remember that trusts have long had a home in the investing foundation of the nation, better known as mutual funds.
Your funds, quite likely. Whether it's the Canadian equity, dividend, balanced or monthly income category, trusts are a common and sometimes large presence. This is fine because you want your fund managers to find the best stocks for you, and trusts have certainly been among the best performers in recent years.
But how much trust exposure do you really want? If you've got trusts laced throughout your fund holdings, and you've got individual trusts or funds holding exclusively trusts, then you may well be placing too much trust in a sector that showed its nasty side just a couple of months ago.
The addition of trusts into the S&P/TSX composite makes it more urgent than ever that investors monitor their trust exposure. A half-weighting of 72 trusts has just been added to the S&P/TSX index now and their full presence will be felt in March. Already, though, income trusts have cropped up in an exchange-traded fund that tracks the S&P/TSX composite. Chalk up more trusts in the portfolios of some investors.
Trusts have done great things for investors since they took off as the tech bubble burst in 2000, but it's pure negligence to let them run wild in your portfolio. For that reason, now is a good time to do a trust audit of your portfolio to make sure you're not overexposed.
CIBC World Markets suggested a 10-per-cent weighting for income trusts in its Canadian Portfolio Strategy Outlook for December, which seems sensible. If your investing goal is mainly to generate income, you might want to push your exposure up to 20 to 30 per cent if you can stand the risks.
The drop in the trust market in October highlights some of the dangers trust investors face. Trusts fell on concern that the federal government was planning to tax them, and then rallied when the tax idea was shelved. There's nothing to stop a future government from revisiting the issue, which would undoubtedly hurt the trust market all over again.
Other risks include rising interest rates for pipeline and power-generating trusts, falling energy prices for oil and gas trusts and an economic slowdown for business trusts. There are also quality concerns about the entire sector these days based on a growing number of trusts that have cut or suspended their monthly cash distributions. Finally, it's worth noting that the S&P/TSX capped income trust index is up a cumulative 115 per cent or so in the past five years, while the S&P/TSX composite is up just 23 per cent.
CIBC World Markets foresees a year of better than 20-per-cent total returns from trusts in 2006, which includes unit price appreciation plus monthly distributions. The idea behind a trust audit is to be prepared in case things don't work out this well.
The trick to finding out what your mutual funds hold is getting your hands on up-to-date information. Recent Top 10 holdings can be found easily on Globefund.com and fund company websites, where you'll also find quarterly updates of the fund's Top 25 holdings.
The 25 largest holdings should be sufficient to give you a sense of how much a fund manager relies on trusts; if not, you can download the most recent fund annual report for the fund on the sedar.com website. Warning: Annual reports can be outdated because they're issued once a year. Another option is the pay website GlobeinvestorGOLD, which has more up-to-date portfolio breakdowns.
Now, let's poke around in a few of the major fund categories to look for some examples of significant income trust exposure.
Canadian equity funds: Income trusts commonly show up in the Top 10 holdings of the most widely held Canadian equity funds. For example, Mackenzie Ivy Canadian had Yellow Pages Income Fund as its sixth-largest holding as of Sept. 30, accounting for 5.5 per cent of assets, while the fifth-largest position in CI Canadian Investment as of Nov. 30 was Canadian Oil Sands Trust at 4 per cent.
Refer to the quarterly portfolio updates for these funds and you'll find that Ivy Canadian has no other trusts, while CI Canadian Investment has 1.6 per cent of its assets in Superior Plus Income Fund. That brings this fund's trust exposure to at least 5.6 per cent.
Some smaller Canadian equity funds are much deeper into trusts. AIC Canadian Focused, a top performer of late with a small, concentrated portfolio, listed CML Healthcare Income Fund, Canadian Oil Sands Trust and Yellow Pages among its largest holdings as of Sept. 30 with a combined weighting of 18.5 per cent (CML was the fund's top holding at 10 per cent of assets).
Consider the iUnits Composite Canadian Equity Index Fund as an example of how index investors will have to be on guard for trust exposure. This exchange-traded fund has been tracking a provisional S&P/TSX composite index with income trusts included for a month or so and the trust weighting was about 11 per cent at midweek.
Canadian dividend funds: There's a big difference between the reliability of dividends paid by a bank or utility company and an income trust distribution, but let's not dwell on that because many dividend fund managers seem to like trusts. Take TD Dividend Income, for example. Canadian Oil Sands was its sixth-largest holding as of Oct. 31, at 4.1 per cent, and trusts over all accounted for 12 per cent of the portfolio (kudos to TD for being one of the few fund companies to disclose the total trust exposure for its funds -- RBC and Manulife are others).
Be sure to check not only the total trust exposure of your funds, but also the types of trusts they own. Acuity Growth & Income highlights the need for this -- it had at least 8.7 per cent of its assets as of Oct. 31 in energy or energy services trusts, which are among the most volatile in the trust sector.
Canadian balanced funds: Funds in this category haven't loaded up with trusts to any great extent, but you'll still find significant exposure in a few cases. For example, CI Harbour Growth & Income had 4.6 per cent of its assets in Canadian Oil Sands and Yellow Pages as of its most recent portfolio update on Sept. 30. CI Canadian Balanced Portfolio, a fund of funds, had 10.7 per cent of its assets invested in CI Signature High Income, which is a dedicated income trust fund.
Canadian income balanced: Those ever-popular monthly income funds are part of this category and pretty much all of them hold trusts to varying extents. RBC Monthly Income, the largest in the category, had about 15.7 per cent of its assets in trusts as of Oct. 31. Its Top 25 holdings show CIBC Monthly Income had at least 9.6 per cent of its money in trusts at Sept. 30, while BMO Monthly Income's Top 25 list showed it had at least 1.5 per cent of its assets in trusts at June 30. (BMO, get the data on your website updated).
An example of a Canadian income balanced fund with a heavier trust weighting is Elliott & Page Monthly High Income at 32.6 per cent.
Natural resource funds: Oil and gas trusts are a viable way to play high energy prices, so don't be surprised to find them in natural resource funds. Example: RBC Energy, the second-largest fund in the category, had about 8.2 per cent of its assets in oil and gas trusts at Sept. 30.
When you've gone through your equity and income funds in search of trusts, tally up your total exposure and then add it to the holdings you have in individual trusts or mutual funds and closed-end funds that hold trusts exclusively (see the accompanying chart for an example of how to do this).
The dated nature of fund company portfolio updates means your audit will produce only an estimate of your exposure to trusts. Still, that's good enough to make sure you're not infested with them.
Are you too trusting?
Income trusts are being added to the S&P/TSX composite index, and they're commonly found in mutual funds of all types. Here's an example of how trust exposure in a variety of funds can sneak up on you.
Your target weighting for income trusts in a hypothetical $50,000 portfolio: 10%
YOUR PORTFOLIO
| FUND | TRUST WEIGHTING IN FUND* | AMOUNT INVESTED | DOLLAR VALUE OF YOUR TRUST EXPOSURE |
| AIC Canadian Focused | 18.50% | $5,000 | $925 |
| TD Dividend Growth | 12.00% | $10,000 | $1,200 |
| RBC Monthly Income | 15.70% | $10,000 | $1,570 |
| Dynamic FocusPlus | |||
| Diversified Income Trust | 100.00% | $5,000 | $5,000 |
| Generic bond fund | - | $15,000 | - |
| Generic global equity fund | - | $5,000 | - |
| TOTAL | $50,000 | $8,695 |
Estimated true weighting for income trusts: 17.4%
*According to most recent fund company data.
SOURCE: GLOBEINVESTOR.COM
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