powered by GlobeinvestorGold.com

Rob Carrick

In this Issue

Question of trusts

Rob Carrick

TORONTO (GlobeinvestorGOLD)—To the skeptics, investing in income trusts now is like getting into tech stocks in early 2000.

As you no doubt recall, the first couple of months of 2000 were the last good days before stock markets slipped into a nasty correction that lingers still. If some investors and analysts see trusts heading in the same direction, wouldn't it make sense to just stay away?

If you've got serious doubts about trusts, it's best to take a pass.

But what if the vagaries of stocks and equity funds have drawn you to the generous yields of 6- to 12 per cent and more that income trusts have delivered throughout the bear market? In this case, you'd probably be agonizing over the amount of risk you'd have to take on to get this highly attractive return.

One way to ease your mind somewhat would be to invest in one of a handful of income trust-focused closed-end funds that have received a top SR-1 stability rating from Standard & Poor's.

Overlooked by most investors because they do almost no marketing, closed-end funds are much like a traditional mutual fund in that they hold a basket of securities chosen by a portfolio manager. The main difference is that closed-end funds are listed on stock exchanges and are thus traded like stocks. There are many closed-end funds traded on the Toronto Stock Exchange, including a dozen or more that hold income trusts.

Only two of these trust-oriented closed-end funds have S&P's SR-1 stability rating, Citadel S-1 Income Trust Fund and Brompton Stable Income Fund. A third fund, Citadel's Series S-1 Income Fund, has received a preliminary SR-1 rating as it heads toward an initial public offering.

Show me the money

The high stability rating offers significant comfort, but don't mistake it for any sort of a guarantee about how these funds, or any individual SR-1 rated trusts, might perform.

In S&P's own words, "Funds rated 'SR-1' have the highest level of cash distribution stability relative to other rated Canadian income funds." Trusts may give you capital gains, but 99.9 per cent of the reason to buy them is for the income generated by their monthly or quarterly distributions. If you have an SR-1 rated trust or fund of trusts, then you have a strong likelihood that your monthly distributions will be uninterrupted (but no guarantees).

An SR-1 rating offers no such guidance on the unit price of a fund, however. If the income-trust market tanks, the Citadel and Brompton funds could easily fall in value, even as distributions remain rock-steady.

Citadel S-1 is the older of the two SR-1 rated closed-end funds that hold trusts, having been listed for trading in late 2000. Its current asset level is about $57-million and its management expense ratio is 1.25 per cent, or a little more than half of what the average traditional income trust mutual fund charges. The $56-million Brompton Stable Income made its debut last December and its MER is 0.95 per cent.

Of the pair, the Brompton fund is probably the more conservative play as a result of a 27-per-cent weighting in investment grade bonds and a 30-per-cent holding in relatively stable power-generating and pipeline trusts. The weighting in the riskiest type of trusts, oil and gas royalty trusts, is just 9 per cent.

A lower risk profile equals a lower yield, which explains why the Brompton fund yields 7.3 per cent. That's on the lower side of what trusts typically yield.

By comparison, Citadel S-1 yields 9.1 per cent. Its holdings include a 16.1-per-cent weighting in fixed income, a 12.3-per cent helping of oil and gas trusts and a 37.2-per-cent holding of power-generating, pipeline and utility trusts.

One similarity between the two is that they both trade these days at a premium of 5 to 6 per cent of their net asset value per unit. Most closed-end funds eventually trade at a discount their net asset value, but Citadel has a consistent record of trading at premium.

If you use the graphing tools available on GlobeinvestorGOLD.com to research these two funds, you'll notice that their unit prices are fairly volatile. Should the income trust sector correct, there's little doubt that the ride will get rougher. Your compensation is a reliable flow of income, which is the whole reason for owning trusts in the first place.

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

Back to top