Income Trust Talk

I still love income trusts, but continue to have mixed feelings about how they’ve been promoted over the years… before and after the 2006 Halloween prank set up by Jim “Flim Flam” Flaherty that effectively puts an end to that category of investment in February 2011. So, we’ve got a year and a bit to go to take advantage of those that remain.

Here’s my dilemma and really the purpose of this site. Income trusts have been promoted as income investments like bonds or preferred shares.  Unfortunately, the similarity ends when you go beyond the fact that bonds, preferred shares and income trusts all provide a steady stream of income… typically monthly for income trusts. Income trusts have typically provided a higher yield than the other two types of investments… hence their popularity.

Let’s compare trusts with preferred shares, the closest counterpart.  Preferred shares are usually issued by large established firms (often banks or utilities). A typical new issue might be offered at $25 with a 3-7% yield, depending on the interest rate environment.  The shares would normally stay in a limited range for years… maybe up or down $2 from $25, so the yield would stay roughly the same.  That’s perfect for an income investor. No capital gains or losses to speak of or worry about… just income above GIC or bank interest rates, plus a taxation advantage.

Income trusts superficially look like preferred shares, but they behave much more like common shares. The volatility is enormous compared to preferred shares and capital gains or losses over a given year are often multiples of the combined 12 months worth of distributions.  That’s why we like them as trading vehicles, and advise against using them as passive income sources.

This lesson couldn’t be proven more effectively than by looking at the fate of income trusts in 2009, compared with 2008.

As I expected the price behaviour of income trusts was exactly like common shares and nothing like preferred shares. For 2009 the average gain on shares included in the S&P/TSX Composite Index was 36% (or +31% if you had invested in the weighted index).

Meanwhile, the average income trust rose +32% over 2009, without factoring in the distributions. Add maybe 10% in payouts and you’ve outperformed the S&P/TSX Composite Index with a diversified income trust portfolio.  It’s inconceivable that that could happen with preferred shares.

But, now let’s look at 2008. The average income trust declined -40% over the year (with no consideration of distributions), while the average S&P/TSX Composite Index
stock lost -30% (closer to -50% from the highs that year). If you had 10% in payouts in 2008, you’d still be tracking common shares.  Preferred shares had nowhere near that level of damage. The good news is that your capital losses were likely reduced by your trust income stream.

The bottom line is that your income yield is likely to be a small fraction of the price swings. That worked in our favour in 2009, but we can’t count on that indefinitely.
Also, dividends from preferred shares rarely drop in value… they increase in value over time. Not so for trusts. It’s not uncommon for an income trust to have a bad quarter and cut or even eliminate the monthly distribution. The consequence is often a -20% or more drop in price over the next day. If you had a 10% yield over the previous two years or a 5% yield over four years, that’s now cancelled out instantaneously with the price drop.

Ironically, all of this is a positive feature for an income trust trader like me, but the worst possible scenario for a buy-and-hold income investor with a portfolio of trusts.

WE DO HAVE A NATIONAL INCOME TRUST ORGANIZATION…  Having said all that, I think that anyone who likes income trusts should continue the battle to keep them alive. We still have a year to go to turn things around. If you’re not on the mailing list for the Canadian Association of Income Trust Investors/Taxpayers (CAITI), you should be… http://www.caiti.info .

I’m  appending some material extracted from the latest newsletter. Brent Fullard, President of CAITI, has sent CBC a “substantial question” that might possibly be posed directly to Steven Harper, if he ever gets back to doing the job he was elected to do.  Shutting down the government, so that all his cronies can go to the Olympics, is a travesty.

My understanding is that once “substantial questions” are posted at CBC, the general population can vote on them. The more votes, the more likely that the question will be posed to the PM and the more media coverage.

Here is what Brent has posed…

Mr. Prime Minister:

During the 2006 Election you promised that you would NEVER raid seniors nest eggs by taxing income trusts. Nine months later you did that exact thing arguing that “circumstances had changed” and that, suddenly, income trusts caused tax leakage. The only proof of tax leakage that you provided Canadians for your tax leakage argument was 18 pages of blacked out documents. How does the use of blacked out documents achieve the level of transparency and accountability that your government also promised to Canadians? Why did you subsequently demand these documents be returned to you, resulting in zero transparency? What is your government trying to hide? Meanwhile reputable private sector groups like BMO Capital Markets and PricewaterhouseCoopers are saying that there is no tax leakage from income trusts, and therefore, your policy actions are WITHOUT justification.

When will your government admit to Canadians that they were misled into believing that you would never tax income trusts in exactly the same way that you are attempting to mislead them on your current hoax about tax leakage?

When will your government take off its veil of blacked out documents and release the truth about tax leakage in order that Canadians can better understand why they lost $35 billion of their retirement savings and the loss of an essential investment vehicle for retirement income for the 75% of Canadians, unlike you, who are without pensions, at a time of pension crises?

Supplemental Question: Could the Prime Minister please comment on the rash of foreign takeovers of income trusts like the $4 billion takeover of Harvest Energy Trust by state-owned Korean National Oil Company or the $5 billion takeover of Prime West Energy Income Trust by state owned Abu Dhabi Energy, to name just 2 of the 51 takeovers to date caused solely by your policy and tell Canadians how much tax revenue is being lost by ALL Canadian taxpayers as a result? Are the estimates by Canadian Association of Income Trust Investors/Taxpayers of an annual tax loss of $1.2 billion a year, rising to as much as $7.5 billion if all the trusts succumb to takeover, accurate?

Brent FullardPresident and CEO
Canadian Association of Income Trust Investors/Taxpayers
www.caiti.info

647 505-2224 (cell)

If you agree with the overall sentiment of that question, by all means, let’s vote for it’s inclusion in the CBC/National Post initiative.  Here’s how Brent sums up the voting process…

How to Vote:

There is no direct link to the question, however voting can still be done in less than a minute.

Therefore, simply go to the main page at: http://www.cbc.ca/news/yourview/2010/01/your-question-period.html#socialcomments-submit

There you will see the following at the top of the list of questions:Entry comments (229)Sort: Most recent | First to last | Agreed

You can sort by time of entry ( by clicking on either “Most recent” or “First to last”) and look for mine (labeled: Brent Fullard) that was posted at: 2010/01/06 at 6:04 PM ET

Or even better, you can sort by “Agreed” which ranks them by popularity. Top to bottom. Mine is currently on page 3 and moving up from where it was at the start of the day on page 15. There are presently a total of 46 pages.

Please ask all your friends and relatives to vote. They don’t have to be Canadians or registered voters. No sign-up or release of personal information is required to vote on the CBC site and you will remain anonymous. It only takes a minute!

Whether you believe in our perspective on income trusts, or choose to invest in them as preferred share alternatives for income only,  we all have nothing to lose by backing this cause!