Market participants are divided on whether income trusts should be included in its Canadian indices, according to a consultation paper published by Standard & Poor’s Canadian Index Services.
The paper, which reflects the contribution of S&P’s Canadian Index Advisory Panel, notes the issue is not a simple ‘yes’ or ‘no’ questions, and summarizes several proposed alternatives. S&P says the report is intended to foster informed discussion of the issue.
According to S&P, there were 160 “operating entity” income trusts listed on the TSX, with a combined market capitalization of $107 billion at the end of September 2004, Since 1997, the market capitalization of the S&P/TSX Capped Income Trust Index has grown at an annualized rate of 37%. Trusts now represent 9% of the total market capitalization of the TSX.
If income trusts had been eligible for inclusion as of the latest rebalancing S&P/TSX composite index, S&P reports that the total market capitalization of the composite index would increase by 8% with the addition of 56 new constituents. There would also be a significant shift in sector weights, with energy increasing by 2.5 percentage points and financials declining by 1.3 points.
“The size and make up of the trust sector, have led a number of market participants to call for the inclusion of trusts in the composite,” S&P notes. “If the composite is to be truly representative of the economic activity in Canada, then trusts, which dominate the real estate sector, account for a large and growing component of the energy sector, and continue to branch out into new sectors, surely belong in the index.”
“At the same time, some market participants, while recognizing the importance of the sector, believe that income trusts should continue to be excluded from the composite, due to their very different structural characteristics and legal status. For these participants the differences raise very serious concerns regarding the suitability of trusts as an investment — particularly for institutions,” it reports.
S&P says it received 17 submissions from a broad cross-section of the investing community.
It adds that many of those opposed to trusts being included in the index set out conditions that they felt would need to be met in order for trusts to be eligible at some future date. As well, many of those in favour of their inclusion suggested intermediate alternatives to outright, immediate inclusion.
The proposed alternatives, as summarized in the report are:
- liability and governance risks should be equalized for common shares and income trust units;
- the Canadian Securities Administrators should develop a National Instrument that provides a governance regime consistent with the regime for corporations;
- effective and uniform liability legislation needs to be passed in all relevant jurisdictions prior to considering all income trusts to be included;
- publish two indexes, a Super Composite including trusts and one excluding trusts;
- allow for inclusion in the index only trusts domiciled in provinces such as Alberta that have legislation providing protections similar to those provided to shareholders; and
- trusts should be phased into the index in an orderly and gradual manner over many quarterly index rebalances.