The Federal Government\u2019s tax fairness plan announced on Halloween 2006 choked off new issues of income trusts, infuriating investors who had bought the products for the high income they promised. But that doesn\u2019t mean the trust sector is lacking in opportunities, product manufacturers say.
With no new income funds on the horizon, the focus has shifted to funds of income trust funds, which typically hold a diversified mix of energy, business and real estate income trusts.
And here, product makers say, all is not doom and gloom. Closed-end funds of income trust funds will continue to kick out steady streams of income up to and beyond 2011, when the tax treatment of income trusts changes. The expectation is that some will evolve into funds of high-paying equities as their underlying investments convert to corporate structures. Others may expand their mandates to allow managers to invest in non-income trust securities.
In any event, product manufacturers say, Ottawa\u2019s decision to curtail trusts has not blunted strong investor appetite for products that generate income.
\u201cAbsolutely, there is a demand for funds that produce income,\u201d says Garth Jestley, CEO of Toronto-based Middlefield Capital Corp. <\/b>
David Roode, senior vice president at Brompton Funds Management Ltd. <\/b> in Toronto, agrees. \u201cThere is a need for high-dividend-paying securities in the Canadian market,\u201d he says. \u201cTrusts were satisfying that need. In 2011, there will still be that need for income. Some trusts will convert, but some will continue to be what would effectively be high-dividend-paying corporations.\u201d
Income-seekers don\u2019t have a whole lot of choice if they want high-income-producing securities. Notes Joe MacDonald, executive vice president of Calgary-based Citadel Funds Corp<\/b>.: \u201cWhat\u2019s your alternative? A GIC, a treasury bill or a 10-year Government of Canada [bond]? Investors will be behind in all of them. Investors will buy the funds based on yield.\u201d
MacDonald\u2019s suggestion is that advisors devote a small portion \u2014 something less than 10% \u2014 of a typical client\u2019s assets to such closed-end funds: \u201cThey are a product that brokers should buy over time.\u201d
Meanwhile, Middlefield\u2019s existing portfolio of 16 closed-end funds of income funds continue to perform very well. \u201cThey deliver the distributions,\u201d Jestley says.
Assets in those funds are invested \u201cin the biggest and best of the income trusts,\u201d he adds. \u201cIn our view, these are viable businesses that will be high-dividend-paying corporations if they don\u2019t remain as trusts [after the 2011 deadline].\u201d
The underlying businesses in the funds of funds \u201cwill be the grist for portfolios of income-producing securities going forward,\u201d Jestley says. \u201cIt won\u2019t come to an end in 2011.\u201d
Consider Middle-field IndexPlus Income Fund, a listed closed-end investment fund that invests 50%-80% of its assets in a diversified portfolio of income trusts that tracks the S&P\/TSX capped income trust subindex. The rest of the portfolio is actively managed within the income trust sector in order to enhance returns and reduce the risks associated with indexing.
The fund was launched in September 2003 with $345 million in assets. As of June 30, its top five holdings were: Canadian Oil Sands Trust (6.4% of assets); waste-management company operator BFI Canada Income Fund (4%); oil and natural gas funds Enerplus Resources Fund (3.6%) and Penn West Energy Trust (3.6%); and CCS Income Trust, which focuses on energy and environmental waste-management services (3.4%).
The fund has slightly underperformed the S&P\/TSX composite index in the period from September 2003 to September 2007: on an annual basis, it has generated an average annual compound return of 16.4% vs 17.7% for the S&P\/TSX. The fund is slated to mature on Dec. 31, 2014.
Thanks to the ability of closed-end fund issuers to raise new capital \u2014 through either rights offerings or exchange offerings \u2014 Jestley expects some closed-end funds will have their lives extended by unitholder votes. \u201cThey will morph from income trust funds,\u201d he says, \u201cinto high-yielding equity funds.\u201d
In the meantime, Roode notes, \u201c[Income trust] yields continue to be good and you have another three years of attractive, tax-efficient income. As well, a number of the funds trade at a discount to their net asset values. So, you buy at a discount and you get paid an attractive yield, a level of income you can\u2019t get anywhere else. Also, I think what happens in three years [when there will be a change in distributions as taxation of the trusts change] has been, to some extent, already factored into the price.\u201d
@page_break@For those reasons, he says, \u201cOver the next three years, there is some good value to be had.\u201d
An example might be Brompton\u2019s Stable Income Fund, which was formed in late 2002 with the aim of providing unitholders with a high level of monthly cash distributions, to maintain Standard & Poor\u2019s SR-1 stability rating, and to preserve the NAV per unit. It has no fixed maturity date.
The fund raised $54 million in its initial public offering and a further $35 million in a follow-on financing in April 2003.
Since inception, it has posted an average annual compound return of about 13.7%. The fund trades at a small discount to NAV. Among its top holdings as of Sept. 30 were Davis + Henderson Income Fund, which supplies financial institutions with cheques and related products (7% of assets); Northland Power Income Fund (5.1%); and Innergex Power Income Fund (4.5% ).\t IE<\/b>
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