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Rob Carrick

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Power play

Rob Carrick

 

OTTAWA (GlobeinvestorGOLD)—When the stock markets plunged in the wake of the 9/11 terrorist attacks, a small group of income trusts exhibited an intriguing coolness under fire.

With stocks of all types being sold off indiscriminately, utility trusts moseyed along as if all was basically fine in the world. If a terrorist act again shakes the capital markets, there's every reason to believe that utility trusts will once more offer bunker-like protection.

Utility trusts are mainly in two areas: electrical power generating and pipelines that move natural gas or oil. Typically, these trusts operate using long-term, fixed-price contracts that offer an unusual degree of certainty about their business prospects. This explains why it is that while 9/11 attacks caused all kinds of panic reactions by investors about possible ramifications for business, utility trusts were largely immune.

The biggest power-generating trust listed on the Toronto Stock Exchange is TransCanada Power LP. It closed at $31.70 on Sept. 10, then dropped as low as $30.40 when the TSX re-opened on Sept. 13. By the end of that day, however, TransCanada had rebounded to $31.25. By the end of the month it had moved up to $32. Utility stocks generally fared well post-9/11, but they weren't quite as impervious as TransCanada. Fortis, for example, was briefly off almost $3, or about 7 per cent, from its Sept. 10 close. For context, let's look at what happened with shares of Royal Bank of Canada, the country's largest and, arguably, most stable bank. RBC shares initially hung in well post-9/11, but by mid-month they had lost more than $5 a share, or 10 per cent.

Other stalwarts in the aftermath of 9/11 included TransAlta Power LP, Great Lakes Hydro Income Fund, Pembina Pipeline Income Fund and Fort Chicago Energy Partners.

One of the investing lessons of 9/11 is that the capital markets get over the initial shock of a terrorist attack in reasonably short order and begin to concentrate on the usual fundamentals. Dominant themes back in 2001 included the bear market and falling interest rates, both of which supported income trusts. Today, we're in a rising rate environment that has already hammered utility trusts. Higher than expected rate increases in the months ahead could do further damage to these trusts.

So why consider them as a hedge against terrorism-linked market turbulence? The answer lies in the reliability of their monthly or quarterly distributions. With their fixed contracts, these trusts clock in their revenue with little or no drama. What's going on Iraq has little or nothing to with small power-generating complexes dotted through some rural and remote locations in Canada and the United States (this is the profile of a typical power-generating trust property).

The ultimate endorsement of the solidity of utility trust distributions comes from rating agencies Standard & Poor's and Dominion Bond Rating Service. If you peruse their stability ratings through a link in the Trust Centre in GlobeinvestorGold's Stocks section, you'll find that utility trusts are almost exclusively ranked well. TransCanada Power gets the top SR-1 (stable) rating from S&P, and an excellent STA-1(low) from DBRS. These ratings tell you that TransCanada has among the most stable distributions of all the trusts rated by these agencies. Other utility trusts tend to be in the SR-3 or STA-3 range, which is comparatively strong in the trust universe, if not as robust as TransCanada.

The reason why distribution stability is so important is that it helps to shield you from the uncertainties that would result from an extended period of global security concerns caused by terrorist acts. If things get bad enough, economic growth might slow and central banks might either shelve planned rate increases or even ratchet rates down a bit. Utility trusts would only benefit in such circumstances.

One of the best things about using utility trusts as a terrorism hedge is that they have value in their own right, not just if things get ugly on the markets. Sure, the unit price of these trusts may dip further than they already have if the world remains calm and interest rates move up as expected. On the bright side, you've got steady income, come hell, high water or terrorist mayhem.

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

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