Farewell to trusts

(November 2006) Cecilia Mo is as soft spoken as they come. In front of a packed audience of advisors attending the final leg of Fidelity Investments’ latest road show last week, she sat uneasily on stage with both hands tightly gripped around a microphone as she shared her views on income trusts. While she is quiet and anxious in front of a crowd, her words are sharp and her views almost callous as she assesses the trusts sector and the way many of these companies are run.

“There are 257 names out there and at least 120 of them I wouldn’t touch,” she says. “Half of them are just pure junk, to tell you the truth.” These aren’t the sort of comments one might expect from the manager of Fidelity’s Income Trust Fund and co-manager on the Fidelity Monthly Income Fund, but she stands by her words.

Earlier in the month, during Fidelity’s swing through Calgary, the headquarters for most of Canada’s energy trusts, she told some of the executives of those firms that she wouldn’t touch them with a ten-foot pole. “The energy trusts by and large are an inferior asset,” she says.

Mo values trusts the same way she values a company, which is why she wasn’t compelled to sell a single unit the morning after Finance Minister Jim Flaherty’s announcement of his plan to tax trusts.

“The way you’ve got to look at this sector is to go back to the fundamentals,” she says. “Ask yourself, if this income trust were to convert to a common stock tomorrow, would you still like it. If the answer is yes, then it should be a keeper in your portfolio.”

Instead of cashing in her units, Mo was using her fund’s 9% cash reserve to buy business trusts she felt were oversold. Some of the companies on her list include Yellow Pages Income Fund, Golf Town Income Fund, IBI Income Fund and Cineplex Galaxy Income Fund.

Notably absent from Mo’s shopping list were real estate investment trusts, which were excluded in Flaherty’s announcement. While she admits she’s made a lot of money off of Canadian REITs this year — and although she still owns a few — she doesn’t see much upside to them, as she expects the Bank of Canada will cut interest rates.

As frank as Mo is when sizing up individual income trusts, she is just as bold in her prediction of what’s next for the investment structure itself. “Income trust in the current format is not going to survive,” she says. “By 2010, with the exception of REITs, most of them will be converting to common stock.”

The ones that don’t survive, she says, will either be kicked out of the market or privatized in the next couple of years. The best trust candidates for privatization, she adds, are the ones that don’t have a lot of debt and have a high yield.

Canada has already experienced a rash of M&A activity this year, which continued its record pace into Q3, according to investment bank Crosbie & Company Inc. Four hundred and twenty transactions were announced in the quarter, representing a total value of $90.3 billion. Through the first nine months of 2006, there were 1,430 M&A announcements, representing a total value of $187 billion, up 64% from 2005.

While the value of these transactions will be hard to beat, the volume of M&A activity could maintain its current pace. As the report notes, “the recently announced decision to phase out the tax advantages of Canadian income trusts is anticipated by many to become a catalyst for increased M&A activity involving financial groups in the future.”

In terms of what this will mean for the trust space, Mo is willing to suggest that even the income trust moniker might disappear, taking the income trust indexes along with it. “It is a shrinking market,” she says. “There are no more IPOs, there are no more conversions.”

Although Mo was surprised by how quickly the market has rebounded, she still expects more volatility in the trust space over the next three to six months. Most of the activity will likely come from American investors. And retail investors, who have no idea what they bought, will sell them due to the tax changes and uncertainty.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(11/22/06)