As bull markets go, you won't see a much livelier specimen than the one that just ended in the income trust sector.
From the bursting of the technology bubble in 2000 to this September, the trust market soared without a serious or sustained pullback. That's finished now as a result of the ravages of an especially nasty October and the risks posed by Ottawa's review of the trust sector, but don't write off trusts just yet.
If you subscribe to the logic of one trust analyst, there are arguments for selectively buying into today's trust market.
"I've sort of been pushing the positive side of trusts," said Harry Levant, a trust analyst who provides research to brokers on IncomeTrustResearch.com. "A lot of the issues in the trust market appear worse than they are and, anyway, the trust market was ripe for a selloff."
Federal Finance Minister Ralph Goodale is not expected to announce the government's plans for trusts until early next year. That means several more weeks of uncertainty for trusts and the potential for more volatility like we've seen in the past six weeks or so.
Ultimately, it's possible that Mr. Goodale could announce measures that hit the trust market hard.
Mr. Levant has no direct pipeline into the Finance Department, but he plays down this eventuality. "I would say the political risk is more than built into the trust market at these prices," he said.
There are several options the department is looking at to address its concerns that trusts are draining tax dollars from the federal treasury and burdening the economy with businesses that are unproductive because they pay most or all of their earnings to unitholders. A benign possibility is an improvement in the dividend tax credit, which would presumably turn dividend-paying stocks into a more appealing alternative to trusts.
Potentially more harmful measures, whether they are a tax on trusts or limitations on the deductibility of interest expenses, would have the effect of leaving trusts with less money to distribute to unitholders. It's this outcome that investors were pricing in when the trust market sank in October, Mr. Levant said.
He said it's reasonable to suppose that the government might introduce a package of measures that have a cumulative result of reducing distributions by 10 per cent. Harsher measures are possible, but Mr. Levant says the political cost to the minority Liberal government would be considerable.
His analysis is that there are nine million voters over the age of 50, which means they're of an age to be potentially interested in trusts. The average turnout rate in an election is 60 per cent, when suggests that there are 5.4 million votes up for grabs from the 50-plus crowd.
Even if the total number of votes from people who care about trusts is one million, you've surpassed the Liberals' 980,000-vote margin of victory in the last election.
"For a minority government, one million votes could be the difference between winning or losing," Mr. Levant wrote in a recent analysis.
Unfortunately, the uncertainty caused by pending government action is only part of the risk profile for trusts right now. Interest rates are rising and that poses a danger for certain types of trusts, notably those in the pipeline and utility areas.
The Bank of Canada nudged up rates last month and some economists think there's another percentage point or so to go in the next 12 months.
But Mr. Levant says much of the current upward pressure on rates is due to the spike in energy prices that followed Hurricane Katrina, and he pointed out that energy prices have tailed off in the past few weeks.
Falling oil and natural prices are good news for all kinds of reasons, but they have a nasty effect on energy trusts.
If prices keep falling, as some analysts suggest they could, then one might reasonably expect that the outlook for energy trusts is bleak. Mr. Levant says he's somewhat optimistic, however.
For one thing, he believes that many energy trusts can produce good results with oil prices $10 to $15 (U.S.) below where they are today.
He also pointed out that many energy trusts used hedging to lock in oil prices when they were at lower levels and thus haven't been able to capitalize on the most recent climb. As its hedging contracts unwind, a trust should be able to realize a price for its output that is closer to market rates.
Care to take the plunge into trusts despite the risks?
Mr. Levant suggests two approaches: buying closed-end funds that hold a diversified portfolio of trusts or focusing on very stable trusts that don't distribute all their earnings to unitholders.
A low payout ratio, to use the technical term, gives a trust a margin of error should business have a need to upgrade its operations, weather a downturn or absorb a tax introduced by the federal government.
Closed-end funds are similar to conventional mutual funds, but they trade on a stock exchange and have lower ownership fees.
Here are four funds suggested by Mr. Levant as being worth a look for investors who want to put money in the trust market now:
First Asset Equal Weight REIT Income Fund: Holds 19 real estate investment trusts, with none accounting for more than about 6.5 per cent of the portfolio. The yield as of late October was 7.6 per cent. The management expense ratio is under 1 per cent, which is less than half of what a comparable mutual fund might charge.
First Asset Equal Weight Pipes & Power Income Fund: This fund holds 20 trusts in the pipeline and power-generating sector, each with a weighting in the area of 4 to 6 per cent.
If you own a fund like this, you're primarily going to get steady, reliable income more than capital gains through increases in the unit price. The yield was an attractive 8.5 per cent in late October, while the MER was in the same low range as its sister REIT fund.
Brompton Advantaged Equal Weight Oil & Gas Income Fund: This fund offers diversified exposure to oil and gas trusts, with a tax advantage for distributions that applies when held outside registered retirement accounts. The MER here is about 1.5 per cent and the yield was recently 11.8 per cent.
SCITI Trust and SCITI Trust II: These two funds track the Scotia Capital Income Trust Index, which means they offer broad exposure to trusts of all types. Energy trusts are the largest component at a little over 11 per cent. The MER is low at 0.39 per cent and the recent yield was 11.5 per cent.
Among the individual trusts Mr. Levant suggests for their strong financial position are Bell Nordiq Income Fund, Gaz Metro LP, Noranda Income Fund and Epcor Power LP.
Whatever fund or trusts you buy, remember that the bull market for these securities is history.
It's back to the future for income trusts, which means they're returning to their origins as income-producing investments and not a vehicle for making a killing in the market.
© The Globe and Mail
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