By David Parkinson
The Globe And Mail
Report on Business
Friday, November 3, 2006

Two words from financial advisers to their clients who own income trusts: Don't panic.

Adrian Mastracci, portfolio manager at Vancouver’s ‘fee-only’ KCM Wealth Management, says, "The sector is hobbled. I think the writing is on the wall."

Of course, many of them have given that phrase a workout over the past 48 hours, as the federal government's proposed new tax on trust distributions knocked the stuffing out of the trust sector. The Toronto Stock Exchange's capped income trust index has fallen 16 per cent in the past two days, and with some experts feeling there could be more downside, a lot of investors are understandably nervous.

"The first thing I tell them is that there are four years for the income trusts to figure out what to do and adjust," said Graeme McPhaden, certified financial planner. "We're taking a long-term approach."

Indeed, despite the rapid selloff of trusts this week, the proposed new tax won't kick in until 2011 for existing trusts -- meaning that many of them could continue paying out their attractive cash distributions for several years yet.

"Keep in mind that income trusts are paying out at a high rate. And if you hold onto them, they will keep paying out at a high rate," said Al Nagy, certified financial planner.

Bill Shaw, portfolio manager, believes all is not lost in the sector. He said investors, as always, just have to be careful which trusts they put their faith in.

"You have to continue to focus on the higher-quality businesses in the sector," he said. That means trusts with low payout ratios, strong balance sheets and solid growth prospects.

For example, he likes Energy Savings Income Fund, a residential natural gas marketer that has no debt and has seen its trust units plunge 26 per cent in the past two days. He also likes XS Cargo Income Fund, off 23 per cent in the past two days, for the strong growth prospects at the clothing clear-out retailer.

He added that the real estate investment trusts have also been sold off along with the rest of the sector, even though they are exempt from the proposed tax. He said Calloway REIT, which lost 3 per cent on Wednesday, has strong management and just made a $1-billion mall acquisition that has positioned the company well for growth.

Other financial advisers, though, are less optimistic about the sector. Adrian Mastracci, a fee-only portfolio manager based in Vancouver, expects that the values of the income trusts will erode as the deadline for the start of taxation approaches, sort of like a maturity date for a bond. As a result, he is skeptical that most trusts will pay out enough in distributions to make up for the declining price of their units as the end draws nearer.

"The price may look attractive, but am I getting any growth here?" he said.

"The sector is hobbled," he said. "I think the writing is on the wall."

Mr. Mastracci has been advising clients not to sell "when there's carnage going on," but he plans to take any bounce in the sector as an opportunity to quietly move them out of trusts altogether.

Professional advisers had typically already limited their clients' exposure to the trust sector, feeling trusts held too much risk and volatility to be any more than a fringe element in a well-managed, diversified portfolio. Even for aggressive clients, they have advised that trusts not represent more than about 10 per cent of the portfolio.

John De Goey, senior financial adviser, has gone even further: He has kept his clients out of income trusts for years.

"This is a lot like technology in the late 1990s, in my view," he said, calling the sector "a borderline Ponzi scheme" where the only increase in value came from more and more investors buying into trusts.

"The income stream you were seeing was really just a return of capital -- you were just getting your own money back," he said. "I don't think any of them represent good value. There are some that are less bad than others.

"The best advisers are the ones going back to their clients today and saying, 'You're welcome -- I kept you out.' "

But fund manager Bill Shaw isn't buying that argument.

"Some of these names have sold off to the point where there's good value," he said. "There are some good opportunities out there in many sectors."

Broad rout, narrow rebound

The income trust sector slumped for a second day as many investors scrambled to cut their losses. Still others sought out opportunities among the beaten down names.

SOURCES: THOMSON DATASTREAM AND BLOOMBERG FINANCIAL SERVICES

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.