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OTTAWA (GlobeinvestorGOLD) — The obvious investing play in a time of rising interest rates is income trusts.
There's no need to adjust your screen. You read that statement correctly. While it's generally true that trusts are rate-sensitive in the same way as bonds, utility stocks and preferred shares, there are nuances here that can work to the advantage of savvy investors.
The key is to zero-in on business trusts that are based on enterprises ranging from fast food and restaurants to shipping, trucking and retailing. Notice a theme here? These are all sectors that have the potential for rising sales at a time when the economy is booming enough to get central banks adjusting interest rates higher. If revenues are on the rise, then a business trust should easily be able to make its distributions and maybe even increase them. The next thing you know, unit prices are moving up as well.
If this is so, then enquiring minds will want to know why it is that pretty much everything else in the trust world except energy trusts got massacred in April as investors decided that interest rates would be on the rise in the not-too-distant future. The best explanation is a herd mentality spurred on by ignorance of the differences between the various trust types. Power-generating and pipeline trusts are much like utility stocks, so they could logically be expected to fall as rates rise. Real estate investment trusts are a debatable case — the malls, hotels and office buildings they own would be more crowed in a rising-rate environment, but their financing costs would also rise. Business trusts are best poised to benefit from a period of strong economic growth, and yet investors have recently treated many of them as if they're going to be crushed when rates move higher. This presents a potential buying opportunity.
The trick is to identify business trusts that have, first, been beaten down and, second, that are in sectors where a heated economy will be good for revenues. Here are some ideas to get you going:
People are bound to dine out more when unemployment is falling, which is positive news for restaurants of all sorts. There are close to half a dozen restaurant trusts listed on the TSX, including A&W Revenue Royalties Income, Boston Pizza Royalties, Prime Restaurants Royalty and The Keg Royalties Income Fund. Boston Pizza held in the best through the recent correction for trusts, while A&W took the hardest hit.
Basic economics suggests these sectors will prosper in a strong economy. Oceanex Income Fund, a Newfoundland-based cargo handler with a strong long-term record, has been slow to recover from a recent pullback. Contrans Income Fund, a trucking outfit, is still well off its 52-week high, as is freight carrier Transforce Income.
There are numerous other business trusts occupying niches that are bound to benefit in a strong economy, including SFK Pulp Fund, which owns a pulp mill, Versacold Income Fund, which is the cold-storage business, and Boyd Group Income Fund, a mover.
The ideal income trust is one based on a solid enough business to sustain distributions through all kinds of weather. So in selecting an economically sensitive business trust, you'll want to consider its ability to make its monthly or quarterly payouts even after the current economic growth phase is over.
For trusts that have been around for several years, check their distribution record through the economic swoon of late 2001 and 2002. For newer trusts, check the prospectus for a discussion of how previous economic challenges were met. The last thing you want to do is buy a business trust that fares well while rates are rising but conks out in the inevitable aftermath of slower economic growth.
Rob Carrick has been writing about personal finance, business and economics for more than 12 years.