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By Fiona Anderson
The Vancouver Sun
Friday, September 15, 2006
With companies like Telus jumping on the income-trust bandwagon, investors who don't currently hold income trust units might want to reconsider.
Adrian Mastracci, Portfolio Manager at Vancouver’s ‘fee-only’ KCM Wealth Management, says, “They’re really equities. People think there is something guaranteed about these things but there isn’t.”
"To have a properly diversified portfolio, you'd be foolish not to look at income trusts as one of the equity elements [of your portfolio] because they are becoming such a bigger part of the market," said Clay Gillespie.
In fact, most people probably own income trusts already through their mutual fund holdings whether they realize it or not, Gillespie said.
But before buying, investors should know what they are getting into.
An income trust shifts the tax burden from the company to unitholders by paying out its taxable income in the form of distributions. Trusts were originally the purview of companies with a steady stream of income but no need to reinvest profits for growth, like real estate holding companies or oil and gas companies that earned royalties, Gillespie said.
But now that businesses like Telus are turning themselves into trusts, investors can't ignore a company just because it's structured as a trust rather than a corporation, Gillespie said.
When a company transforms itself into a trust, shares are usually traded for trust units without immediate tax consequences to the holder, Gillespie said. But what does change is the size of distributions investors receive, and that does have tax consequences.
Because trusts distribute most of their income, distributions are usually much more than a shareholder would have received as dividends. For example, Telus anticipates it will distribute between $3.90 and $4.10 per unit each year, while its annualized dividends were only $1.10, a more than three-fold increase. The size of the distributions makes trusts look very attractive, Gillespie said.
"Income trusts became very popular when interest rates were low because they were giving distributions of seven or eight per cent," Gillespie said. "And as bond yields went down, people generating an income were looking for another animal."
But what some people don't realize is that some of the distributions may be a return of the investor's own capital, or may be depreciation or anything else a company could write off, Gillespie said.
That can add complicated tax and accounting issues to income trust ownership and also mean that when the units are sold, there could be greater taxable capital gains.
Gillespie also warns investors that with the trust paying out most of its earnings it's virtually impossible to determine whether the company is keeping enough to ensure its business stays afloat.
"That for sure we won't know until history tells us," Gillespie said.
Investors shouldn't buy income trusts hoping for capital appreciation despite good returns in the past. Between May 2002 and May 2003, when the TSX index fell 8.6 per cent, the median income trust unit went up 7.4 per cent, Gillespie said. But he attributes that rise to investors' love of the high distributions without a true understanding of the investment vehicle.
In the future, Gillespie says, income trust units are unlikely to appreciate as they have in the past and may even fall in value.
Adrian Mastracci, portfolio manager with KCM Wealth Management, believes many people are holding too many income trusts in their portfolio because they are fooled by the word "trust."
"The word [trust] implies they're solid as a rock," Mastracci said. "Some might be, but I think you have to look at them as you would equities."
"They're really equities. People think there is something guaranteed about these things but there isn't," he said.
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