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Choosing an Income Trust: S&P Stability Ratings Are a Good Place to Start

by Wayne Cheveldayoff, 2003-04-06

With many income trusts offering annual cash yields of 8 to 11%, investors are naturally attracted to them. But choosing one or more for a portfolio can be a daunting task.

For one thing, there are more than 100 income trusts listed on the Toronto Stock Exchange. Sifting through the details for even a tenth of that number would be very time consuming.

These trusts, also known as income funds, include: royalty trusts, where the income stream is generated by oil and gas or mineral reserves; real estate investment trusts (REITs), where cash flow comes from commercial rental property income; and specialty business income trusts, which invest in a variety of businesses from hydro-electric power to pet food manufacturing. The trusts essentially operate as any business would but pass through most or all of cash flow directly to investors, who are responsible for paying any income taxes that would apply.

Another challenge in choosing a trust is getting a true perspective of the trust’s prospects and its ability to sustain its cash distributions. While trusts report on financial performance regularly at and their own web sites, very few offer predictions, and there is also the danger that such predictions could be self-serving. Some of the larger trusts are covered by brokerage analysts, but most investors would not see that research as it is only available to clients of the brokerage house. Even if that research is available, its reliability may be suspect if the brokerage also participates in new issue financings for the trust.

Investors doing their own research may want to start with Standard and Poor’s stability ratings concerning cash distributions. While no rating system in a changing world is fool proof, the S&P ratings are the only objective tool available at present.

The rating agency assigns ratings ranging from ‘SR-1’ (the highest) to ‘SR-7’ (the lowest) for approximately 27 income trusts and these can be relied upon. S&P has access to internal detailed information that investors don’t normally see.

The trusts pay S&P a fee to provide a rating, but S&P determines subsequently what the rating should be and the agency has a solid reputation for objectivity built from successfully rating bonds for many decades.

The fact that S&P charges a sizeable fee may be why the majority of trusts in Canada don’t ask to be rated. Another factor, as S&P itself notes, is that some trusts may worry that the rating may be lower than what investors are assuming to be the case.

An important factor for investors is that the cash distribution yields available on the trusts that are rated usually correspond to the ratings. For instance, those rated ‘SR-1’ have annual yields around 8%, whereas ‘SR-2’ rated trusts have yields of approximately 9%. Those with lower ratings usually have yields in excess of that.

Also, ratings can vary drastically even for trusts operating in the same business sector. Pipelines have been assigned stability ratings ranging from ‘SR-1’ to ‘SR-4’, and real estate funds have been rated between ‘SR-2’ and ‘SR-5’.

At this time, S&P is the only rating agency publishing its ratings, although Dominion Bond Rating Service recently announced that it will be rating all trusts (whether or not they pay) and publishing the ratings for investors.

The S&P Income Fund Stability Ratings and accompanying articles and analysis are available at (select Canada from the top navigation bar, then choose the Products and Services tab and click on Canadian Stability Ratings Guide from the featured list).

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at

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©2003 Wayne Cheveldayoff