A view to a trill

Just because we live and work in Canada doesn’t mean we own the place — or does it? A new theoretical investment option that would allow investors to have an equity stake in the country’s economy could be on the horizon.

But don’t think you can start calling the shots just yet. The “trill” — an idea proposed by Mark Kamstra, an associate professor of finance at the Schulich School of Business, and Robert J. Shiller, a professor of economics at Yale — isn’t anywhere near implementation. And if it does get into advisors’ hands, clients will own just one-trillionth of Canada’s GDP.

The trill is similar to a share issued by a corporation that pays dividends. In its case, though, the coupon payments would be adjusted depending on how much the GDP rises or falls in a given year.

“I teach MBA students and I kid them that I’d like to be able to pay them now and get an income on the rest of their life,” says Kamstra, explaining that investors would buy a stake in the economy today and reap the rewards that a well-funded government can provide.

Kamstra, who wrote about the trill in a C.D. Howe Institute report, says that the investment option would provide investors with a new source of income that would be protected against inflation and exposed to income growth. He calculates the annual rate of return at 8.4%.

For diversification purposes, the trill is hard to beat. Kamstra says it’s almost completely uncorrelated with any other types of fund flows as it’s based on GDP growth, not market factors. “If I can buy a new asset class whose income is uncorrelated with everything I own, I can diversify away a lot of risk,” he says.

Kamstra figures that investors can reduce their risk by nearly 50% without affecting the average rate of return. With that type of risk, he says, he’d put about 40% of his net worth in trills.

The price of a trill would be determined in the same way as other government securities, with market prices quoted on a daily basis. Kamstra says that governments could issue trills in large denominations so buying them through a mutual fund or ETF would make the most sense.

He also expects the government to issue them in perpetuity, reserving the right to buy them back at market prices.

The professor can’t think of any downsides to the trill, though in a recession, coupon holders would be hit hard as the GDP would decline and the trill price would fall. He admits some might be unsure of buying the investment option in today’s turbulent market, but Kamstra points out that the GDP is actually going up, so the trill price would increase as well.

He also imparts that the trill is a long-term investment. “It would be less volatile than a publicly traded equity but similar in volatility day to day,” he says. “It’s not the type of asset a nervous investor would want to look at every day, but it’s great in the long run.”

While this sounds good enough, the Canadian government might not be so quick to jump on the trill bandwagon, as it would be more expensive to issue than traditional debt.

Kamstra predicts that it would cost about 1% more per year than debt products because the government is putting some of its risk onto the investors. Even though the trill is a relatively safe option, “any instrument that loads risk onto someone else will be a bit more costly for the issuer.”

For the government, raising money in this way would mean it wouldn’t have to take on more debt. Kamstra explains that corporations run into trouble when they issue too much debt and there’s a major inflow/outflow imbalance.

Of course, the government isn’t going to go bankrupt like a company might, but it’s still important that it doesn’t take on too much debt. “This is great from a government risk management perspective,” he says. “The outflows would vary with tax revenue. From that perspective, it makes sense to issue these.”

The author says the government wouldn’t use the money it gets from issuing trills for additional spending. If anything, the dollars would go toward unfunded liabilities. “This way everything is above board,” he explains. “It’s a way for the government to clean up its books.”

So far, the trill hasn’t been adopted anywhere in the world, though options similar to it have popped up. Kamstra says he has spoken to the Canadian government about this, but while it thinks it’s interesting, it’s not ready to commit to anything.

Time will tell if the trill will enter our investing lexicon the way stocks and bonds have, but if you take Kamstra’s word for it, it’s only a matter of time. “There’s a gap in the market, and this will fill it,” he says. “And there’s no downside for investors who would like to protect themselves against inflation.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(08/12/08)

Bryan Borzykowski