Income 'Trusts'/Funds (paragraph 3 new Dec 1'05; paragraph 5 new November 18 2005)
Most of the common stock we hold was bought years ago. With growing dividends, the yields are now better than those currently offered by income trusts. So I don't buy income trusts. If I needed the higher current income, I don't think I'd buy income trusts anyway. I don't like them. Their business model is flawed. Income trusts are different. They are kind of equity, yet they are not. They certainly don't have the guarantee of a bond or the coverage of deposit insurance. If you are being tempted toward an income trust "for the income", here are some thoughts you might consider. Above all else, be certain to check the credit rating on the "trust" you are being sold. I would never consider an un-rated business income fund.

Go to the DBRS site, click on Income Funds near the top centre of the page and see if the one you are considering is listed. (DBRS began analysis - stability ratings - of the power generating and pipeline income funds in the Spring of 2003.)
http://www.dbrs.com/web/sentry?COMP=100

Check out the S&P ratings too at:
http://www.standardandpoors.com/canada/ratingsactions/ratingslists/index.html

Realize especially that the quoted 'yield' is not really the yield...often it involves return of capital. Some of the "income" you receive could be your own money coming back. But the Street people call it yield. Ask your self why the yield on these creations is so high. If they were really good investments, would the yield be so high?
Most trusts pay out some 90% of their cash flow. Ask yourself: Is there is room for income growth? Is there room for any growth at all? Where will the money for growth come from if 90% of cash flow is paid out? Management will have to issue debt, new equity (diluting your holdings) or reduce payouts. Then ask yourself why the income trust type of structure is not common in the States? (hint: bitter experience in the 1970s)
NEW DEC'05 From the lead editorial in the mid-November 2005 issue of Investment Executive: "That reliable curmudgeon, forensic accountant Al Rosen, has just issued a report warning that the trust boom isn't just a tax play; it's also part accounting shenanigan, part marketing phenomenon. Rosen is rightly concerned that many retail investors don't understant what they're buying." The editorial continues "when a market sector grows this fat this fast on the backs of retail investors, regulators would be wise to be worried".

Comments on 'trusts' from other sources:
3. "Trusts pay little or no tax at the corporate level and instead leave investors to pay taxes." Rob Carrick Report on Business November 24 2005 Connolly's comment: The dividend tax credit does not apply to income from trusts...the income is fully taxable at your marginal rate. You could say trust income is already grossed up. The yield on trusts is higher: so is the tax.
If you are thinking of a business income trusts be aware of a report on business income trusts prepared in November 2005 by the Accountability Research Corporation an affiliate of Rosen and Associates forensic accountants. "The report questioned the ability of trusts to fund the cash distributions that have made them so popular with seniors and other investors focused on income." Globe and Mail November 25 2005 James Daw had a terrific column in the Toronto Star of November 24 2005 (http:www.thestar.com) The title was: "Income trust study raises red flags'. Here are a few ideas from the column:
"Retail investors who own the bulk of income trusts (this fact alone says a lot) do not recognize that less than two-thirds of the cash distributions they receive come from income or profit, while the rest is a refund of their original capital."
"Seventy-five per cent of the fifty largest business trusts - including Yellow Pages, Aeroplan, ... distribute more cash than they earn as income." Hello!
4. Ira Gluskin penned a column about income trusts in the July 30 2005, Report on Business. Gluskin said, " In my view investors in trusts should expect to earn a distribution of 7.5 per cent and consider themselves lucky if they generate capital gains." Coming from a chief investment officer who seems to like income trusts (27% of his $2.8 billion portfolio is in trusts), this is very telling. Ira Gluskin is president and chief investment officer of Gluskin Sheff and Associates. Notice Gluskin's choice of the word 'distribution': he did not say yield. Notice too, that Gluskin is, in effect, saying that trusts probably will not produce capital appreciation. It must be true: it comes from a person whose portfolios hold $800 million in trusts.
Common stocks, on the other hand, especially those with regualar patterns of dividend growth, can produce capital gains. That's why common stocks are better than than income trusts, bonds and preferreds. Eventually, with dividend growth, common stocks will produce more income that income trusts...and capital gains to boot. In the last paragraph of his column, Gluskin asks, "who is going to win at the end of the day?" At the end of the day, income trusts...maybe. But, at the end of the decade, common stocks with growing dividends will win hands down.

5. Income Trusts - "higher-quality business trusts are pretty much as risky as junk bonds". I took this sentence from the front page, lead column in the Report on Business of Thursday November 17 2005. The sentence was attributed to analyst Barbra Gray who follows income trusts for independent investment dealer Blackmont Capital. The headline of the column was "Ranks of ailing trusts swell". Apparently, 22 trusts have trimmed or suspended their payouts since May of 2003. WOW! And here, with prices of trusts down so much since September, I was thinking of buying one. I'm changed my mind when I discovered the one I hadthought looked good was not rated. I'd better stick to what I know best. Yields on HDGs are lower, but the companies are growing and so yields will grow and will capital. The chances of getting both these features from any of Canada's 230 income trusts are slim.
Actually, the ROB column by John Partridge was well done. Among other ideas, it contained a list of danger signals: "a ratio exceeding 2 per cent of debt to earnings before interest, taxes, depreciation and amortization (EBITDA); an estimated 2006 payout ratio exceeding 90 per cent of distributable cash; and a pretax yield of more than 12%". McLean and Partners Wealth Management used these danger signals or 'red flags' to peg 83 income funds most likely to cut or suspend distributions. It would be an interesting list to see if you owned a fund, eh. I've found a few good ideas on the McLean web site before, but I doubt this list of 83 trusts would be there.

"The bottom line is that you are buying a projected stable stream of tax-advantaged income and not growth per se. An income-trust investment is something akin to a preferred share - a common-share investment with fixed-income characteristics." The MoneyLetter/May 2003 Eric Kirzner
"You buy income trusts in order to enhance the returns of your portfolio-not its growth prospects!" Eric Kirzner
Making a true yield calculation on a income trust is complex: distributions from income trusts can include ordinary income, dividend income, capital gain and return of capital. There are tax complications too.
Ask yourself this question before you buy. "Why are smart, successful entrepreneurs selling these companies to the public in an income trust form?" Bruce Campbell Canadian MoneySaver November 2002
"Also, these entities cannot grow their way out of a problem. They need the co-operation of capital markets to raise money for any acquisition, otherwise they have no ability to grow." (Bruce Campbell, Canadian MoneySaver, November 2002) Why? Income trust pay out most of their cash flow to shareholders.
"With an income trust, you're essentially buying cash flows, not an underlying asset" Doug Steiner, Report on Business magazine, January 2003
"[Y]our neck will hurt from price-decrease whiplash is interest rates rise." Doug Steiner, Report on Business magazine, January 2003
Income trusts are not noted for increasing their payouts. Report on Business April 26 2003
For some income trusts "the income you receive is partly or largely a return of your capital. For others, the income producing asset may deplete all too soon." Carlyle Dunbar Investor's Digest Sept 19, 2003
"The merits of income trusts have been oversold and the risks of holding them underplayed." Carlyle Dunbar Investor's Digest Sept 19, 2003
Because most of the income is paid to IT unitholders, "management won't be able to accumulate internal funds and that could mean they won't take advantage of investment opportunities as needed". Rob Heinkel, Canadian Investment Review Spring 2003
Income trusts (IT) "seem to be 'priced' in terms of their 'yield', which is usually taken to mean the last year's cash payout dividend by the current value of the IT. For ITs with very stable payouts, this might be meaningful. However, investors may understand and interpret the yield as what will be paid out in the future." Rob Heinkel, PMF alumni professor of finance, UBC
"What's driving this racket? The hunger for new fees led bankers to match investors' search for high yields with mature, slow-growth companies and their owners, who were desperate to unload them." Forbes October 27, 2003 p 136
"the less attractive consequence of adopting a trust structure is that the company would no longer be able to build shareholder value through retained earnings." Jon Kanitz The MoneyLetter November 2003
"In the end, trusts pay out all their earnings to shareholders, and therefore they are no place for people who like growth" Mathew Ingram, Report on Business November 24 2003
John Kellett, manager of RBC's $2.9-billion Dividend Fund, has avoided most income trusts, according to Derek DeCloet writing in the Report on Business of January 1 2004. "When you pay out the bulk of your cash flows, it's hard to sustain the business model", Kellett says.
The pension funds want regulators to beef up income trust disclosure rules in the areas of executive compensation, asset valuations and debt. R.O.B. Jan 13 2004 Watch for inordinately high management fees.
"Under the income trust model, companies distribute most of their profits to unit holders rather than retaining earnings for capital expenditures and growth." Richard Bloom, Report on Business February 25 2004
"Simply because something is labelled a 'trust' by no means makes it trustworthy." Benj Gallander and Ben Stadelmann Feb 25 2004 ROB
"Just like bonds, the higher the income trust yield, the higher the risk." Rachel Michaud Canadian MoneySaver March 2004
'Income trust distributions are not guaranteed and can fluctuate." Rachel Michaud Canadian MoneySaver March 2004
Income trust "yields are high for a reason. In the long run, there should be little or no capital appreciation. If you can sell your trust units five or ten years down the road for what you paid for them, be happy. If you want growth, stay with common stocks." T. Edward Gardiner, Investor's Digest May 21 2004
"When to stop growing and convert to a trust" was the headline in a Report on Business story in the December 9 2004 issue. The headline says something about trusts, don't you think.
"there are too many inconsistencies in the way income trusts calculate and report their distributable cash..." attributed to Marc Tellier president and CEO of Yellow Pages Group in Report on Business February 21 2006
Murray Edwards, the outgoing chairman of Penn West Petroleum, before it was convested to a trust, told shareholders, according to the report on Business of May 28 2005, "he was concerned about the long-term prospects of trusts, particularily whether cash distributions are being made at the expense of needed capital investment". Conversion to a trust by Penn West allowed options held by managers to vest so their holders could immediately cash in. This is an oppressive transfer of value to the detriment of shareholders.
Al Rosen, a forensic accountant, wrote a marvelous column about income trusts in February 2006 Canadian Business. If you can still buy and unrated trust after reading Rosen's column, you deserve the return you won't get.
"It should be remembered that an income trust is just a low-growth company that pays a high yield to investors. This asset class does not provide safety of principal nor guarantee income." Bruce Campbell, Campbell & Lee Investment Management, Oakville, in MoneySaver April 2005
I have not read it myself, but am told that Canadian Income Funds by Beck and Romano, a small soft cover book, is good

http://www.burgundy-asset.com/nov-97.asp - a four page item on income 'trust' management fees...

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Energy "Trusts" from Feb 2002 Connolly Report
I don't follow them, or buy them, but I was not surprised to learn that cash distributions by some energy trusts have been slashed to a fraction of their former levels. As a result, prices of these units have fallen dramatically...a double whammy for their holders.
With the lower unit prices, is it time to buy? It seems not. In a column about energy trusts by Lily Nguyen in the December 20, 2001 Report on Business, there were a number of insightful comments by analysts who follow these units. The analyst in Calgary, for instance, who covers trusts for TD, Steve Larke, said, "I have a hold on every trust I cover". And we know what "hold" means. Larke does not expect cash distributions to recover for some time. And he went further. Speaking about Pengrowth, he told Lily Nguyen that based on the 13¢ distribution, the 12% return is not high enough given the commodity price risk. Interesting!
I stick to common stock for dependable income. I understand common stock And dividend reductions are much less likely to occur with common stock. Real corporations set regular dividends in a way that they can reasonably be expected to continue.

I was curious about the uniformity of income provide by energy trusts. This table (Sorry. Not available on line.) outlines monthly income for last two years and two months for Pengrowth (PGF.UN)...it's quite variable, eh.
For stability of income relative to other rated funds, S&P rates some Canadian income funds. As of February 2002, on a scale from SR1 (highest) to SR7 (very low), Pengrowth is rated SR4: "moderate". As trusts are sold, not bought, I would not consider an un-rated income unit. Three funds are rated SR1: TransAlta Power LP, TransCanada Power LP, Citadel S1 Investment Trust.

"Energy trusts deemed risky" was the headline in the Report on Business, January 12 2004 with the sub-title: "S&P study says distributions will come under pressure as oil, gas reserves fall". "Oil and gas trusts, also known as income funds", the column continued, "have depleting assets with finite lives and distributions that can swing wildly over the course of a commodity price cycle the report cautions".
"...cash distributions payouts [from energy income trusts] are also at risk from the typical volatility of the oil and gas industry" Yahoo Finance, Reuthers based on S&P report January 12, 2004
"investment trusts are at their zenith in a low-interest-rate environment" February 25 2004 Gallander & Stadlemann