Sentiment mixed on future of trusts

(December 2006) A month after the federal government’s about-face on tax policy, there is still no consensus on the future of income trusts. But there does seem to be sufficient doom and gloom to go around.

A new poll released by Deloitte shows that most executives think the sector will collapse by 2011, when federal taxation of distributions begins. There are currently 256 publicly traded income trusts in Canada, but 87% of poll respondents said there will be fewer than half that many four years from now. In fact, 52% said they expected there to be fewer than 50.

“When changes to the taxation of publicly traded trusts and partnerships were unexpectedly announced by the government at the end of October, the business community responded with confusion and outrage,” said Brent Houlden, Deloitte partner and national leader, trusts and partnerships. “While uncertainties about the pending legislation are still unanswered, there is growing recognition of the need to move ahead by responding proactively to the proposed changes and thereby rebuilding investor confidence.”

The survey was conducted at a seminar hosted by Deloitte in Toronto, with 360 executives in attendance. Participants included managers and trustees of income trusts and their advisors, and investors and lenders.

In Deloitte’s survey, 55% of respondents said trusts will likely increase their payout ratios, flowing more capital out to investors before the tax is imposed than they otherwise would.

The road to taxability is expected to be a rocky one for investors, according to the survey, with 58% predicting further declines on the income trust index. Eighteen per cent said they expected the tax measures will restrict growth.

It is commonly held that trusts grow by acquisition, using their valuation premiums as leverage. Those premiums were derived from their tax efficiency, so the theory is that they will struggle without their higher valuations.

But that discounts the trusts that have managed to grow organically. These trusts may even see their unit value climb over the next four years if they are able to grow their distributable cash enough to compensate for the tax hit.

“It creates an interesting dichotomy,” says Les Stelmach, research analyst, Bissett Investment Management. “Do you buy the high-yielding, but certain to decline in price, trusts, or the lower yielding, but reasonably certain to increase in value, trusts?”

Not everyone is convinced that trusts face certain doom as a structure.

“I think the reports of the income trust’s death have been greatly exaggerated,” says Leslie Lundquist, manager of the Bissett Income Trust Fund. “While I don’t think we’re going to see the growth that we’ve seen in the past, I do think we will find a way for investors to continue to enjoy equity-type investments that have high yields, and that something will happen to allow investors to continue to benefit from that kind of investing.”

In her eyes, the immediate sell-off in the trust sector was an overreaction, which punished some of the better quality trusts along with those that deserved to be sold.

“I think there really is a lot of bad news and fear and shock and uncertainty in the market now,” says Lundquist. “When we look at the companies themselves, they’re doing fine. When we look at distributions, we have every expectation that good trusts will continue to pay out stable, growing distributions.”

She suggests trusts may morph into a new form, with investment banks already working on developing new structures that would preserve the advantages of trusts.

“A lot can happen in four years,” she says.

But Deloitte’s report suggests that trusts may not have the luxury of the full four years to decide their strategy.

“The clock is ticking; year-end reporting requirements necessitate management of many trusts to announce their strategic response within months,” says Houlden. “The various options need to be assessed not only in terms of ‘what to do’ but also ‘when to do it,’ while still striving to focus on business results.”

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

(12/11/06)

Steven Lamb