Top picks
from today’s hottest fund group
The class
of income trust mutual funds is something of a mixed bag with some investing
exclusive in income trusts and others with a healthy dose of bonds and cash
(like balanced funds). Morningstar Canada counts thirty-two funds in the
category in all. If we exclude segregated funds (i.e. sponsored by insurers)
and others in the category with rich management expense ratios (MERs), the
category shrinks to ten. A final screen excluding funds that are no longer
accepting new money and those with lackluster performance leaves just a handful
standing. This week, I’ll profile my favourites – in order of preference.
One of the
first funds to be launched in this sector, this one’s also the cheapest (MER of
1.25 per cent). But don’t be fooled by the low price tag – it’s not at all
indicative of this fund’s quality. Lead manager Rick Howson has always talked
about preferring trusts that had the brains (i.e. management) housed inside of
the body (i.e. the trust) – rather than outsourcing management. The reason is a
closer alignment of interests between management and shareholders.
This along
with broad diversification, and Howson’s keen insight and sensitivity to
valuations has been beneficial to fund investors. Howson’s target income trust
exposure is rising from 70 to 90 per cent due to the growth of the income trust
sector. The impact of this change will be twofold: a) a slightly higher yield; and b) slightly higher volatility. This
fund remains my top pick among this class. (And it’s worth noting that this
fund pays a trailing commission to financial advisors.)
Eric
Bushell is a great talent among Canadian money managers. His shift to managing
this fund (launched in 1997) was a natural transition after years of managing
interest sensitive portfolios (starting with BPI Dividend Income several years
ago – now known as CI Signature Dividend Income, which he still runs). With
less than 60 per cent in equities, this is structured more like a balanced
fund.
Bushell
doesn’t buy into the idea that the market is shifting to favour “growth”
investing. He says that the economy will disappoint next year since many
industries are operating well below capacity. Since he thinks companies simply
don’t need any more capacity at the moment, he doesn’t foresee business
spending returning anytime soon. However, he’s bullish on the energy sector
and, as a result, has about 40 per cent of this fund in royalty trusts. Nearly ¼
of this fund is also positioned in corporate bonds; which represent good value
today.
Lead
manager Oscar Belaiche says income trust valuations are fair but adds that a
demographics-driven demand for higher yields will keep income trusts from its
volatile past. He maintains that the attractive yield on quality trusts will
act as something of a self-pricing mechanism. If prices rise so high that
yields don’t offer enough of a premium over guaranteed products, prices may
fall. If prices drop too much, yields will be so attractive that investors will
jump in and start buying. This only holds, of course, if the yield is
sustainable and somewhat predictable.
Belaiche
targets about 1/3rd into each of royalty trusts, real estate
investment trusts (REITs), and general business trusts. He’ll over- and under-
weight each area according to his outlook, but the focus remains on finding
quality investments. Belaiche’s wealth of operational experience allows him to
recognize quality management – and more importantly, bad management. Hence,
he’s careful to avoid the junk this sector has to offer.
GGOF was
the first firm to launch a dedicated income trust fund back in October 1996; so
lead manager John Priestman has already seen two major contractions in the
relatively young income trust market. Words of caution about lower quality
issues will get no argument from Priestman, but he chuckles at the idea of a
valuation-induced bubble in the sector.
Income
trusts were absolutely slaughtered from late 1997 through to late 2000 – to the
extent that Priestman says today’s valuations represent nothing more than a
return to more normal valuations. This fund was launched after the original was
closed to new money. This won’t be a clone of the original – but one that is
small enough to buy some of the better, but smaller, income trusts in today’s
market.
Barry
Morrison of Morrison Williams Investment Management runs this fund, which is
more of a balanced fund. Roughly 60 per cent is positioned in equities (nearly
all of it in income trusts) with the remainder sitting in cash. Morrison guides
this fund with the firm’s top-down view of the economy. His Calgary base gives him
easy access to the oil patch’s big players and properties – a sector which
forms the core of this fund’s holdings.
The big
cash balance is the result of both strong sales into the fund as well as some
recent ‘sells’. He’s happy to hang onto some cash for the time being since he
acknowledges the possibility of price weakness in the income trust sector – and
will use the cash to seize buying opportunities as they present themselves.
Bissett
Income and GGOF’s original Guardian Monthly High Income are two excellent funds
no longer available to new investors. But if you already hold either of these,
I’d hang tight. If you need to rebalance, consider doing so by redirecting new
money into other investments rather than selling units in these capped funds.
Whatever
you do, don’t go overboard on these funds because their returns have sizzled
over the past year. Return chasing is the vicious cycle in which investors have
been caught for many years. Use these funds as they’re designed – as part of
your equity allocation but to boost cash flow taken from your overall
portfolio.
Dan Hallett, B.Comm., CFP, CFA is the Senior
Investment Analyst with Sterling Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, Alberta, and Manitoba.