The assault on income trusts

The headline in The Globe and Mail last Wednesday caused me to sit bolt upright in my easy chair.

“Goodale says public appears to back income trusts move,” it read. The article went on to say that the Finance Minister told the House of Commons that feedback to his department since he announced the suspension of advance tax rulings on trust conversions is running “about 75 per cent in favour of the position the government has taken.”

Now, far be it from me to question the credibility of a senior minister of the Crown. I’m just curious to know exactly who is sending these laudatory comments and precisely what it is these folks like about his move. Perhaps Mr. Goodale would be kind enough to table a sampling of these favourable responses in the Commons so that we can all be enlightened.

Certainly, the reaction he says that Finance is receiving is a lot different from what is turning up in my e-mail box. Most people seem to be angry, confused, anxious, or a combination of all three. I have yet to receive one that praises Mr. Goodale for doing a great job on this file.

Personally, I believe he has botched the whole process. Leaving investors to twisin the wind for months is inexcusable. However, there are a few positive things that may flow from this debacle. Think of this as the half-full glass view of events.

Elevating the level of public debate. The income trusts consultation paper released by Finance in early September elicited a huge yawn. Because it was so neutrally worded, no one interpreted it as a signal of a pending government crack-down on the booming sector. That’s why everyone was blindsided by Mr. Goodale’s announcement — the assumption was that the government would do nothing until after the consultation process was finished on Dec. 31.

Now all the sound and fury on this issue will keep the story front and centre right through the fall. The process has already started with testimony before the Senate Banking Committee. Look for a parade of high-profile financial people to visit Ottawa in the coming weeks, from economists to pension plan managers. The only folks who probably won’t be there are the ones who will be most affected by the ultimate decision — retirees who have come to rely on the cash flow from trusts to supplement their income.

By the time Dec. 31 arrives, the whole trust issue should have been thoroughly aired and we’ll all have a good idea of the pros and the cons involved. Then we’ll see what the government does — although, as I said a few weeks ago, I fear they may have already made up their minds on this issue.

Blowing away the froth. There’s no doubt that the income trust market had become overheated. I’ve been warning for some time that prices were too high and there was very little value to be found. The problem has been exacerbated by the appearance of several marginal IPOs that in normal circumstances would never have surfaced.

Mr. Goodale’s move knocked back the prices of most trusts, at least temporarily, creating a few bargains in the process. It also kicked the props out from under several issues that were about to begin raising money from the public. A few of those looked interesting; most did not.

Enhancing risk awareness. I’ve warned repeatedly that trusts are not bonds and that there is a significant risk element involved in the sector. However, the high yields appear to have prompted many people to turn a blind eye to this risk.

In the days immediately following Mr. Goodale’s announcement, the sector declined but what I estimated to be about $7.5 billion in market value. I received e-mails from people saying they had lost tens of thousands of dollars on paper as a result. They blamed the Finance Minister and rightly so — it was his political intervention that precipitated the market plunge.

But the reality is that a correction was in the cards anyway, although it would probably have been more gradual. Prices were too high and yields had fallen too low commensurate with the risk. Hopefully, investors will now be more critical in their analysis of trusts and focus on those of the highest quality.

At this point, it would be rash to speculate on what course Mr. Goodale will take. However, I would be surprised if we see any significant changes to the rules governing REITs and energy trusts. In his first attempt to tackle the problem, in his 2004 budget, the Finance Minister exempted them from his proposed limit on pension plan holdings. That seems to be a pretty clear signal that the government does not regard them as a major concern. It’s the business trusts that have Ottawa fretting, and that’s where investors need to tread carefully until a new policy is announced.