Choose an income trust fund

Many retirees like the idea of investing in income trusts because of the good cash flow they offer. But there is concern about the safety of these securities – we keep hearing dire predictions that suggest the income trusts market is going to implode. Well, don’t worry about it! It won’t happen.

Yes, there will be broad market corrections, just as in the stock market. In fact, we experienced one in the spring when investors aggressively sold because of worries about impending interest rate hikes. As it turned out, they overreacted, in the process creating bargains for those with stronger nerves.

And yes, there will always be individual trusts that get hammered because of poor management, or falling revenues, or financial fiddling, or decreased distributions. We have seen examples of all of these this year in such cases as Atlas Cold Storage, Heating Oil Partners, and Hot House Growers Income Fund.

Sector on verge of collapse?
So investing in income trusts is not risk-free and never will be. But is the sector about to collapse? Not likely. About the only thing that could change that view would be draconian action byhe federal government to change the tax rules and apply them retroactively, which is a non-starter because of the size of the sector.

Otherwise, only a huge and sudden spike in interest rates could send the whole sector in a tailspin.

Events such as a drop in oil prices would certainly impact energy trusts but other types of trusts would be unaffected. In fact, some would actually see improved returns if that were to happen.

I feel that a well-managed income trusts portfolio is the best way to invest in these securities because the diversification reduces the overall risk. So let’s look at some options.

Dynamic Focus+ Diversified Income Trust Fund. If you want a genuine income trust fund, this will be to your liking. Just over 90 per cent of the portfolio is invested in trusts, along with small holdings in preferred shares, convertible debentures, and cash.

The portfolio, which is managed by Oscar Belaiche and the venerable Ned Goodman, is well-diversified with 33.7 per cent of the assets in resource trusts, 25.6 per cent in business trusts, 17.8 per cent in REITs, and 13 per cent in utility trusts.

Because of the heavy focus on income trusts, it should come as no surprise that this fund is one of the top performers in the category, but also one with the highest risk level. One-year return to Sept. 30 was 26.1 per cent compared to an average of 21.6 per cent for the peer group. Over three years, the average annual compound rate of return was 24.5 per cent against an average of 16.1 per cent.

The fund is currently paying distributions at a monthly rate of 8c a unit but it is important to note that it has not been as consistent in the amount of its payments as some of the other funds of this type. Cash yield over the 12 months to the end of September was 7.7 per cent. However, if distributions are maintained at the same rate the cash yield over the next year based on a recent NAV of $15.04 would be down to 6.4 per cent.

Still, that’s a reasonable yield and there is capital gain potential here. Just don’t lose sight of the risk level.

Next page: Three more picks

GGOF Monthly High Income II Fund. This fund was created to replace the original Guardian Monthly High Income Fund after it was capped. Its major disadvantage is a slightly higher MER than the original. Otherwise, it is pretty much a clone of the first one in terms of management and asset mix. Both funds pay monthly distributions of 6c a unit and both have about the same return over one year. However, the new one does not yet have a three-year record. Like the Dynamic fund, this is a true income trusts fund with 95.3 per cent of the portfolio invested in that sector. Business trusts, resource trusts, and REITs dominate, with between 27 per cent and 31 per cent of the assets in each case. Based on the current distribution rate and an NAV of $12.38 the projected cash yield from High Income II over the next 12 months is 5.8 per cent.

Saxon High Income Fund. Anything from the Saxon organization is worth a look and this fund is no exception. It is heavily weighted towards income trusts, although there are some common stocks like Royal Bank in the portfolio as well as a small percentage of bonds. Although over the longer term the results are slightly above average, the latest one-year gain of 16.3 per cent falls short of the category average of 21.6 per cent. Distributions are paid quarterly, not monthly, and are variable. Over the year to Sept. 30, unitholders received a total of 76.7c per unit, for a cash yield of 7 per cent. About 40 per cent of the 2003 distributions were tax-deferred or tax-advantaged. The two major advantages that this fund offers over the others reviewed this month is a low MER and no load charges if units are bought directly from Saxon.

Signature High Income Fund. This fund is offered by the CI organization. It is classified as a Canadian Income Trusts Fund and on the surface it appears to be exactly that, since the top 10 holdings all fall into that group. But dig a little deeper and you’ll find this isn’t really an income trusts fund at all. Rather, it’s a balanced fund along the lines of CIBC Monthly Income Fund and RBC Monthly Income Fund. The largest single asset sector in the fund is corporate bonds, which make up 31.2 per cent of the portfolio. Common and preferred shares account for another 11.1 per cent of the assets, while 9.7 per cent is in cash. That means less than half the portfolio (48 per cent) is actually invested in the trust sector.

The track record of the fund is decent, with slightly above average returns. As you might expect given the diversified nature of the portfolio, risk is relatively low compared to the income trusts category generally. The fund makes monthly distributions of 7c a unit and over the year to Sept. 30 generated a cash yield of 7.2 per cent. The bottom line is that there is a lot a like about this fund. But it really belongs in the Canadian Balanced category, at least until a new Canadian Balanced Income category is created.

Any of these funds will do a decent job for you. However, at this point the Dynamic fund is the leader when it comes to both cash flow and capital gain potential. Before you invest, however, be sure to talk to a financial advisor.