Trusts will get more respect, expert says

(January 23, 2004) Sooner or later, the powers that be will need to take a hard look at adding income trusts to the S&P/TSX Composite Index, according to Stephen Probyn, chair of the Canadian Association of Income Funds.

“We think that there will be the inclusion of income funds in the TSX composite index,” Probyn told the Canadian Institute’s third national summit on income trusts yesterday in Toronto, pointing out that income funds are the fifth largest sector by market capitalization. “It’s increasingly difficult to have a composite index that doesn’t include 12% of the equities.”

One oft-cited reason for the exclusion of income trusts from the indexes is the issue of unlimited liability, a theoretical threat that investors would be on the hook for any liabilities incurred by the trust.

This issue is downplayed by most Bay Street lawyers, but it is also partly to blame for the so-far tepid response from pension funds, which have been reluctant to buy into anything but the most stable trusts.

“As this market becomes much larger, we are starting to see institutional participation in some of the larger deals,” Probyn said. “We are seeing a nascent pension fund class. We see in the next phase, much greater pension fund exposure to income fund assets.”

He says the baby boomers are forcing pension funds to seek higher income earnings as they begin collecting their benefits. There are few assets that offer the immediate high return that income trusts do.

Trust unitholders are already protected by legislation in Quebec, with B.C. and Alberta considering similar laws this spring. Ontario almost passed legislation in 2003, but Probyn says a timing error killed the bill when the provincial Tories called an election, which they then lost. Probyn says the new Liberal government has offered a commitment to passing unitholder protection legislation.

“We believe this spring we will have in place the legislation we’re looking for,” Probyn said. “That will then, we believe, pave the way for inclusion of the income funds into the TSX Composite.”

Another potential reason for the exclusion of trusts is the confusion which has surrounded them in the past. When they became popular during the stock market slump of 2001 and 2002, many investors looked at them as a sort of debt instrument.

Probyn emphasizes that trusts should be considered as high-yielding equities — a message that seems to be accepted now throughout the investment community.

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There have been rumblings in the past year that the federal government would rewrite the tax code, closing the tax benefits trusts carry. Because trusts are structured to pass their earnings on to investors as interest payments, rather than dividends, they pay no corporate tax.

The cash trusts pass along is taxed in the hands of investors, leading some to speculate the government is losing out on up to $1 billion a year in tax revenues. Others point out the taxes are still collected as personal income tax and at the time the trust is first set up, and that the trust structure is revenue neutral to the government.

Either way, the point may be moot. Since income trusts are so widely held, it is unlikely the Ottawa will move to alienate such a large group of voters.

“What’s important about income funds is not their tax status, but the way in which the redefine the relationship between investors and the businesses in which they invest,” says Probyn. “They’re part of a movement for investors to get the cash.”

He says trusts are “good for Canada” in that they have provided good returns and provide an opportunity to invest in the “meat and potatoes” of the economy — like real estate and energy — which employ many Canadians.

Most companies in the intermediate oil and gas sector have converted to the trust structure or disappeared altogether.

“The trusts have offset to some degree the hollowing out that many commentators talked about,” he says. “There are new head offices springing up every day.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(01/23/04)

Steven Lamb