Trust legislation ramifications

It initially didn’t rate more than a brief mention on the inside pages of the business section. But the passage of the trust protection bill by the Ontario legislature just before it adjourned for the Christmas break could have important ramifications for the burgeoning income trust sector and for Canadian pension plans.

The thrust of the Ontario bill is to protect investors against being held personally liable for the actions of a trust, its directors, or its management.

That means they can’t be hauled into court or have their assets seized in the event a trust in which they hold shares is involved in a major environmental disaster, a medical scandal, a financial fraud, a construction collapse, or any of the other risks that confront business enterprises in their day-to-day operations.

Shareholders in limited companies have always had this protection, hence the term “limited liability”. But trust investors (including those who own mutual funds) have not been immune. Legal experts have always contended that the risk was minimal, but even that was enough to cause some people to steer clear.

Investments that do not carry limid liability can become a financial nightmare, as some of the “names” who put money into Lloyd’s of London have discovered in recent years. That’s why many pension funds have made it a policy not to invest in income trusts or to keep their holdings to a minimum, despite the attractive cash flow they generate.

Change may mean better returns
Now, with Ontario, Alberta, and Quebec all having passed protective legislation and British Columbia planning to do the same, the entire situation has changed. All trusts based in those provinces (the great majority) are covered across Canada. The pension plans are now free to add to their trust holdings, and many are likely to do so. That could mean better returns and hence higher pay-out to future retirees.

This was exactly the scenario Finance Minister Ralph Goodale feared when he unsuccessfully tried to cap pension fund holdings in income trusts in his 2004 budget. If the pension industry becomes too aggressive in its pursuit of income trusts, watch for Ottawa to try again in 2005.

Look at the marketplace
Meanwhile, the pension plans and ordinary investors can bulk up their own portfolios without fear of being sued, unlikely as that ever was. However, before you place your buy order you need to take a long, hard look at the marketplace. You can be sure the professionals will be doing so.

Most income trusts are very expensive right now – I might even say overpriced. The S&P/TSX Capped Income Trust Index was up 15 per cent in 2004, well ahead of the gain registered by the S&P/TSX Composite Index, which tracks stocks only and does not include trusts. At some point, we are going to see a correction in the trusts sector. I can’t tell you exactly when it will be, but I consider it inevitable.

That will be the time that pension plans are likely to more aggressively to add to their positions. Until then, they are likely to make only modest commitments to the sector. Individual investors would be wise to emulate them.