By: Michael Kane
The Vancouver Sun
Personal Finance
Friday, January 10, 2003

Some investors simply can’t wait to pour money into income trusts

Big Rock Brewery is the latest company to jump on the income-trust bandwagon, an investment sector so hot in Canada that some critics have described it as the next bubble waiting to burst.

The Calgary-based maker of premium beer says stockholders and option holders have “overwhelmingly” approved the company’s conversion into the Big Rock Brewery Income Trust.

The company says it is well positioned to generate consistent income for unitholders because it has an established position in the beer market in five provinces, with low maintenance and capital requirements.

The Big Rock conversion highlights the soaring popularity of income trusts with income-seeking investors faced with anemic stocks markets and low returns from fixed-income investments.

Like stocks, income trusts must be chosen very carefully. They can offer a good stream of regular income but are often sold as fixed-income alternatives when they are equities, says Lynne Triffon.

“It is very important to be aware the income stream is not guaranteed and is a function of the continued success of the underlying business.”

If the business falls on hard times, as happened in the oil and gas sector in the 1990s when the price of oil fell to $10 a barrel, the income could evaporate.

Adrian Mastracci, a fee-only investment counsel with Vancouver’s KCM Wealth Management, cautions some investors are over-exposed to income trusts because they are the latest hot thing and they will typically miss the exit signs when the sector cools off.

“Income trusts aren’t a bad thing,” he said. “It is just there will always be some investors who go overboard.”

An income trust is an enterprise that pays substantially all its income to unitholders in monthly or quarterly cash distributions. Income trusts are like stocks in that they can increase or decrease in value but their appeal to investors is regular income, which is typically double or better than the yield available form bonds or GICs. Much of the income is taxed at lower rates if it qualifies as dividend income or capital gains.

Some lower-quality income trusts offering yields in the low to mid teens and above face trouble ahead, according to credit rating agency Standard & Poor’s.

“S&P expects there will be a flight to quality because the levels of distributions being promised by some funds are clearly unsustainable,” analysts wrote earlier this month.

When distributions are cut, investors will bail out and bid down the unit price of the trust.

Some investors are also likely to exit the sector if interest rates bounce back sharply or if the equity markets stage a strong recovery.

Talk of a bubble has percolated as income trusts took off to the point at which they accounted for 86 percent of a record $5.8 billion worth of corporate initial public offerings in Canada last year. However, many industry observers maintain fears of a bubble are overblown.

John Ditchburn says income trusts are “a self-correcting mechanism,” in which people will sell units of trusts that don’t perform until the yield is again at a competitive level.

“You look at an income trust at you would any equity in a company. Is it a good business, how volatile are the earnings and how reliable are the management? That’s what makes or breaks an income trust.”

Excluding the volatile oil and gas sector, the majority of income trusts are delivering returns in the eight to 10-percent range.

However, some of the companies that converted to income trusts in 2002 may have done so for the wrong reasons, cautions Leslie Lundquist.

“There is certainly a place for income trusts in any well-balanced investment portfolio, as long as you have absolute confidence in the trust’s income stream,” she said. “That way you can ride through any valuation declines in the sector.”

Some of the larger income trusts launched on the Toronto Stock Exchange in 2002:

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.