You can still trust in income trusts at this late date, but keep them on a short leash.
Trusts have been on a multi-year rally that has to end some time, yet they can still be useful to investors who abhor the low returns available from guaranteed investment certificates and bonds.
Your success with trusts going forward will depend on how you manage them in your portfolio. If you're conservative and patient, you'll do fine.
Here's a game plan for investors who have added trusts to their portfolio without an overall strategy, or for those who may be taking a first look at them because of the attention they received in this week's federal budget.
The budget removed one of the biggest worries of trust investors -- that Ottawa would tax trusts and thus leave them with less money to distribute to unitholders every month or quarter.
These distributions are the essence of trusts, which are businesses in almost every economic sector that pass their earnings to unitholders, who in turn pay income tax according to their own situation.
Many trusts have soared in value over the past several years thanks to low interest rates and because they offered a welcome refuge as stock prices crumbled. But if you buy trusts now, you should be doing so for the distributions and not for capital gains.
In fact, you could well end up with capital losses at some point, on paper at least. Should that trouble you? If you're buying trusts for gains in the unit price, sure. Trusts are probably a bad bet for this type of investor right now.
But if you're investing for income -- if you're unhappy with a 4.2-per-cent return on a 10-year Government of Canada bond, for example -- then trusts can work well.
Here's where the short leash comes in. You don't want to get too deep into trusts right now because they're at such high price levels.
Gavin Graham, vice-president and director of investments with Guardian Group of Funds, suggests putting no more than 20 to 25 per cent of the income portion of your portfolio in trusts.
The remainder of your income investments could go into GICs, bond funds and bonds.
"Trusts are extremely valuable in raising the yield of your portfolio," said Mr. Graham, who oversees several funds with heavy weightings in income trusts. "But it must be said that they're subject to volatility."
Whether you buy individual trusts or a fund of trusts, you'll find that the unit price fluctuates from day to day.
Sometimes, this can be severe. Canadian Oil Sands Trust (COS.UN-TSX), the largest income trust by market capitalization, fell almost 16 per cent, or $8.33, in a single day earlier this month after some bad news about cost overruns at the Syncrude oil sands project in Alberta.
Taking a hit on the unit price of your trusts or funds holding trusts hurts because it affects the overall value of your portfolio. What matters more, however, is the ability of your trust holdings to continue to generate income.
If the unit price falls and the income's still there, you're fine. You bought trusts for income and you're still getting it. As for the price of your trust units, it should recover provided the underlying business is sound. (Mr. Graham says this is the case with Canadian Oil Sands, by the way).
If you're new to trusts, you face the question of whether to buy individual issues or a fund. Fund management expenses mean you'll get significantly less yield than you might if you blended a few individual trusts.
Guardian's flagship $1.2-billion GGOF Monthly High Income Mutual Fund now yields approximately 6 per cent -- you'd get more if not for the fund's 2.55-per-cent management expense ratio.
The benefit of owning a fund is that you get the protection of a well-diversified portfolio. "Canadian Oil Sands is our single-biggest holding, but when it got whacked a few weeks ago the fund was actually flat for the week," Guardian's Mr. Graham said.
This fund's diversification also served it well during the lean times for income trusts in 1998 and 2000. Even though the trust market was much smaller and more constrained then, GGOF Monthly High Income Mutual managed to maintain the same 6-cent distribution each month.
Anyone who feels overwhelmed by the choice of 140 or so trusts out there should buy an income trust fund, be it a mutual fund or one of the many closed-end funds of trusts listed on the Toronto Stock Exchange. If you're confident in your abilities to choose trusts, then you'll quite likely achieve better returns on your own.
Regardless of what vehicle you buy, the theme is income. If you buy into a fund or trust that yields 7 per cent on your investment, then that's your ideal return.
Trusts have delivered a lot more than that because of unit price gains, but don't expect that to last indefinitely.
© The Globe and Mail
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