Superman never made any money, as the Crash Test Dummies song tells us, but if he did he'd probably invest it in income trusts.
The man of steel and trusts were made for each other. Both have arch-enemies -- Lex Luthor for Superman and Ralph Goodale for trusts. Both defy gravity -- Superman can fly and income trusts have appreciated by an average 20 per cent annually over the past five years, which in the investing world is the same as flying.
One small difference -- Superman is invulnerable except for Kryptonite, whereas trusts have no weaknesses as far as we can tell. They've battled rising interest rates, falling energy prices and a review by Mr. Goodale that looked at one point like it could have resulted in a new tax on trusts.
Today, trusts are mostly unscathed -- their prices are almost back to the peak they reached in early September, before Mr. Goodale started talking the market down.
Invincible investments? Aside from guaranteed investment certificates, they're as real as Superman. That's why you should consider these five guidelines for venturing into the trust market right now.
1. Mind the risks. Mr. Goodale chose not to introduce a tax on trusts last week, instead opting to deflate the trust market by making dividend stocks more attractive with a cut in taxes on the income they provide. Still, there are indications the government was considering some kind of a tax on trusts right up until the last minute. If trusts continue to proliferate, it's possible this tax could be revisited.
Other risks to consider include rising interest rates, which are nasty for power-generating and pipeline trusts. There are signs that inflationary pressures are easing and that there may not be a lot more upside for rates, but there's still some uncertainty here. Energy prices have been weak lately and if this persists, it could hurt oil and gas energy trusts. Note, energy trusts account for a big portion of many income trust mutual funds and closed-end funds.
2. Ignore new trust issues. A resurgent trust market will allow well-known companies converting into trusts to price their units in such a way as to pay lower yields than you can find in existing quality trusts.
Conversely, higher-yielding trusts that you've never heard of can be dangerous. Two examples are FMF Capital Group, an American mortgage finance firm that went public in March at $10 a unit and is now in the 80-cent range, and Arriscraft International, which has fallen to about $3.75 from $10 over the past year. Both, it must be noted, have suspended their monthly cash distributions.
3. Dig into the numbers. Some day, the trust sector will get its act together and agree on common standards for defining how much income is available for distribution to unitholders. There's too much leeway right now in defining these numbers, which means it's impossible to create a standard format for determining the all-important payout ratio, or the percentage of income paid out to unitholders.
This leaves investors in the position of having to ferret out their own data. Consult analyst reports where you can, and be sure to look at trust quarterly earnings reports, if only to compare final profit and distributable cash with cash distributions actually paid. Alarm bells should go off if a trust regularly pays out more than it takes in, or even if it's handcuffing itself by paying out almost everything.
If you can't make any headway with payout ratios, at least consult trust stability ratings from Dominion Bond Rating Service and Standard & Poor's. These reports size up a trust's ability to consistently make its monthly payouts and they can be viewed at no cost on Globeinvestor.com's Trust Centre.
4. Ignore high-yield trusts. A trust's yield reflects many factors, but it's still a good all-purpose indicator meter. Yields in the mid- to high teens are a clear warning that investors are worried about the security of future cash distributions.
Low yields aren't necessarily a good thing. They can suggest a trust has run up a lot in price, or they may reflect that investors see a trust as a growth play that is more about capital gains than income.
5. Remember, they're income trusts. Superman took a breather every now and then as Clark Kent, mild-mannered reporter. Income trusts are bound to do the same, which could mean an extended period in which they make their monthly distributions while unit prices go sideways or decline.
There could even be a rout ahead for trusts, something worse than what we saw in October as investors worried about what Mr. Goodale might do. If you're hung up on invincibility, there are always GICs or comic books.
© The Globe and Mail
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