The big news is Bay Street
While you were busy last month watching the dramatic defection of Belinda Stronach and the cliff hanger budget vote, other events that could affect your livelihood were happening.
The income trusts sector was especially active with all sorts of newsworthy events taking place. Among them:
• Standard and Poor’s Canada unveiled a complex timetable for bringing income trusts into the TSX indexes.
• ACE Aviation, the parent company of Air Canada, confirmed that a minority position in Aeroplan will be spun off into an income trust in what has already become the most sought-after IPOs this year.
• The powerful Ontario Teachers Pension Plan Board publicly blasted the trust conversion plan of Penn West Petroleum, raising serious issues of corporate governance.
• A prominent forensic accountant warned that some income trusts are in danger of collapse and demanded that securities regulators take action to protect investors.
Whew! And you thought Parliament was exciting! Let’s take a quick look at each of these developments.
Large change ahead
</strngThe S&P timetable for bringing trusts into various TSX indexes (not just the Composite but also the MidCap and SmallCap indexes) is understandably cautious. I’ll spare you the tedious details; you can find them elsewhere. The important point is that we are looking at a huge change in the structure of Canada’s key stock indexes and at this point I don’t think many people understand the full implications of what is about to happen.
RBC Dominion Securities issued a report in which they identified 64 income trusts with a current market capitalization of more than $90 billion as potential additions to the S&P/TSX Composite. When the full integration is completed in March 2006, the new additions will change the make-up of the TSX significantly and increase the divergence between it and the major New York indexes, which do not have anything akin to income trusts in their composition.
The S&P/TSX Composite will be even more heavily weighted towards resources (seven of the 10 largest trusts are resource-based, with six of them in the oil and gas sector). Its dividend yield will jump dramatically because of the high trust distributions, making historical comparisons meaningless (although there will be a parallel stock-only index). All the TSX indexes will likely be more heavily influenced by interest rates because of the sensitivity of the trust sector to rate movements. The net result could be even more volatility in the day-to-day fluctuations of the TSX then we’ve seen in the past.
Look for Aeroplan’s move
Moreover, the influence of the trust sector on the TSX is likely to grow unless the federal government takes steps to rein it in, which is increasingly unlikely. So far this year, more than $5 billion worth of new trust IPOs have come to market with more on the way. The Aeroplan deal isn’t a particularly big one at an estimated $250 million but keep in mind this represents less than 20% of the business. If the Yellow Pages IPO is any indication, all of Aeroplan’s shares will eventually be offered to trust investors, giving us yet another billion-dollar plus income trust.
Corporate governance to the fore
The rush to convert to income trusts has once again brought the matter of corporate governance to the forefront. The Ontario Teachers Pension Plan pushed the issue back into the headlines last month but it has been simmering for some time and needs to be properly addressed. There is no doubt that some trust conversions are really little more than giant cash grabs for the principals involved and the on-going business plans are shaky at best. Securities regulators have been surprisingly quiet about the whole sector. It’s time for that to change. Trusts need to be subject to at least the same degree of scrutiny as public corporations although, heaven knows, even that is less than adequate in this country.
Income trusts scams?
That brings me finally to the allegations made by forensic accountant Al Rosen in which he compared the income trusts situation to the Nortel debacle. He was quoted by Advisor.ca as saying that “Half of income trusts will turn out to be scams. I am very confident of that.”
What a disaster that would be! It would mean that tens of billions of dollars would be wiped out at some point, a financial calamity for trust investors, many of whom are retirees who depend on trusts for income.
But don’t panic! I don’t think we’re going to see anything like that happen. However, Mr. Rosen will have done us a service by speaking out in such strident terms if it causes investors to pause and consider the risks before committing too large a percentage of their portfolios to trusts and if his dire warning prompts regulators to get off their backsides and take steps to bring a higher level of governance and responsibility to this burgeoning sector.