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Good news for income trusts and a shift to Canadian equities

Income trusts have had some encouraging results this year, says this advisory, which also thinks you should be investing more in Canada.

There’s a chill on Bay Street and Wall Street these days — or is it a fever? Now they’re not just worried about investors’ money, but about their own futures. But there’s not much to be gained by dwelling on this uninspiring picture. It’s time to look at a brighter picture, which we find in the world of income trusts.

What’s going on is not the worst news you will find in the financial pages these days. Income trusts did very well last month. Even yesterday, the S&P/TSX Income Trust Index finished the day in positive territory.

For the full story, we turn to a leading authority on the subject, the Income Trust Guide published by the Money Reporter. This advisory will tell us which trusts have performed particularly well, and what it means for the trust market.

After that, we’ll find out why Canada is a safer bet for investors these days and what’s the best way to invest in Canadian equities from the Money Reporter itself.

The story the indexes tell

So far this year, the S&P/TSX Composite Index is down more than 6 per cent. The Income Trust Index is down less than one per cent. In February, the trust index rose 3.8 per cent, leavings stocks in the dust.

Indexes don’t tell the whole story, of course. “Now, we know some of our subscribers don’t like measuring performance by looking at indexes,” admits the advisory, “and they have a point. After all, you invest in specific trusts, not indexes.”

But the indexes do tell an interesting story. For one, they tell us that energy trusts have been going “gangbusters,” rising almost 10 per cent for the year when this issue of the advisory was published last week. Real Estate Investment Trusts (REITS), on the other hand, were down almost 12 per cent.

“So if a particular REIT you own is up over the same time frame, or a particular energy trust you own is down, it’s important to know that it did so against a headwind.”

Good news for the trust market

There’s another development that this advisory finds somewhat puzzling, yet encouraging at the same time. Taken together, the trusts on its recommended lists came in lower than the overall trust index.

In fact, those trusts declined 0.44 per cent. What does this mean? Well, those are just short-term numbers, and these hand picked trusts have generally gone in the opposite direction. The advisory has every reason to believe that “our recommended trusts have a higher average quality than the overall index.”

The good news is in the big picture. “This difference in returns would therefore tend to indicate that it was the lesser trusts, not the higher-quality ones, that gained the most ground,” says the advisory. “That in turn is good news for the trust market as a whole.”

But it is not sufficient reason “to start abandoning our strategy of owning quality trusts.” The weaker trusts may have gained a good deal of ground, but to bet on their sustained success would seem to be a very iffy proposition.

Nor did the Income Trust Guide’s list of recommended trusts fail to yield some big gainers. Chief among them is one of the advisory’s favourite trusts.

33 years!

Canadian Oil Sands Trust (TSX-COS.UN) rose by 16.8 per cent last month — and it hasn’t broken stride in the first two weeks of March, either. But then, its price is just catching up to where it should be. The trust has “just added to its already long reserve life of 33 years (33 years!), and is thinking about boosting its production targets from current levels,” comments the advisory.

Canadian Oil Sands is on the advisory’s Best Buy list for March.

As you would suppose from the gusher achieved by energy trust, this giant is not the only one on the advisory’s recommended list that did well. In fact, even with the price of crude breaking barriers, this advisory recommends just five energy trusts. And all five followed the trend upward, including another one that is currently a Best Buy.

Enerplus Resources Fund (TSX-ERF.UN) was up 11.3 per cent last month. Even when the price was down, the advisory remained steadfast: buy. Perhaps investors may now be wondering if its status will change after such a dramatic price rise. “Again, no change,” states the advisory. “It’s a buy.” Enerplus can’t quite match the stupendous reserve life of Canadian Oil Sands, but its 14-year horizon is much longer than most. It is also about to merge with Focus Energy Trust.

Higher exposure to Canada

The other three energy trusts that rose were: ARC Energy Trust (TSX-AET.UN), which rose by 11.9 per cent; AltaGas Income Trust (TSX-ALA.UN), “a relative newcomer to our list,” up 7.3 per cent; and Freehold Royalty Trust (TSX-FRU.UN), which rose 4 per cent last month.

Even in the battered group of REITs, one stood out. Canadian Apartment Properties REIT (TSX-CAR.UN) rose by 4.1 per cent last month.

Before we put the final touches on this relative happy income trust story, we’ll look at the third and final Best Buy of the Month from the Income Trust Guide.

Series S-1 Income Fund (TSX-SRC.UN) is a fund of income trusts. The advisory is advocating higher exposure to the Canadian equity and trust markets, at the expense of foreign stocks. “This fund is a way to add some exposure to trusts, while maintaining diversification and not disturbing your core portfolio. Use a limit order and let the price come to you.”

The strong performance of trusts at a time when markets can’t be trusted would seem to be yet another proof that they remain a very appealing alternative for a significant group of investors. One good month does not a long-term success story make, but those plucky trusts just won’t go away.

Now we’ll see why it’s a better idea to be in all kinds of Canadian investments these days, according to this advisory.

The elephant in the room

“Income investors have every reason to be concerned about current equity market forecasts,” says the Money Reporter. “The elephant in the room is the U.S. economy: various reports have it heading into a recession, narrowly avoiding a recession, or soon coming out of a recession.”

Whichever of these assessments proves to be correct, it’s a moot point, says the advisory (and probably even mooter after the events of the past few days). None of them is good.

Nor does the rest of the globe offer much in the way of refuge. “Europe is a tale of two economies,” the advisory explains, “with half of the countries growing too quickly, and half in the doldrums.” Investing in a European index is like banking on a net return of nothing.

Japan is looking warily at recession, while those emerging economies we’ve loved so much over the past few years — China and Russia, in particular — are preparing for slower economic growth.

“Here at home,” adds the advisory, “we are not immune to the credit crisis, subprime problems and U.S. slowdown, despite the protests of the new ‘decoupling’ school of economics. However, we maintain that being in Canadian equities and income trusts is relatively preferable to being in equities anywhere else.”

So while you shouldn’t get out of U.S. and foreign equities altogether, a tactical shirt toward Canadian securities is called for. But how?

One fell swoop

“One way to add Canadian exposure without wrecking a carefully contructed portfolio of Canadian stocks and trusts is simply to add either Canadian equity iShares or a Canadian equity index fund to the list,” says the advisory. “But which is better for long-term gains?”

For the uninitiated, iShares are shares in exchange-traded funds (ETFs). The one this advisory follows regularly on behalf of income investors is the iShares CDN LargeCap 60 Index Fund (TSX-XIU), which mirrors 60 of the largest and most heavily traded stocks listed on the Toronto exchange.

“Because they trade like stocks,” adds the advisory, “one advantage of ETFs over mutual funds is that you can use limit orders, stop orders and good-through orders for example.” Plus ETFs often have put and call options, which offers even greater flexibility in trading.

One advantage of ETFs over index funds lies in the management fees. Index funds are created to track a certain index and generate the same returns, says the advisory, “but they almost never do because of the Management Expense Ratio or MER.” The average MER on Canadian equity funds is 1 per cent. By contrast, the MER on the iShares CDN LargeCap 60 Index is a mere 0.17 per cent. Over time, that seemingly small difference can make quite a large difference.

The disadvantage of an ETF is that you generate a commission every time you buy shares. So if you buy shares regularly, you may be better off using a no-load index fund.

Ultimately, says the Money Reporter, the choice is this: if you plan to increase your Canadian equity exposure “in one fell swoop,” do so with the iShares CDN LargeCap 60 Index. If you plan to add to your holdings over time, you’re better off with a no-load fund. It recommends PH&N Canadian Equity, which has an MER of 1.13 per cent.

The moral of this story is pretty clear. Keep all your options open as an investor — income trusts, equities or funds — and you don’t have to be controlled by the madness in the markets. When Bay Street gets a chill, you don’t have to catch a fever.