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Big pension funds point the way for small investors

by Wayne Cheveldayoff, 2004-07-01

For small investors trying to save enough for retirement in RRSPs, itís worth keeping track of what the big guys are doing.

OMERS, one of the largest pension funds in the country, has recently declared that it cannot earn enough from stocks and bonds, so it is shifting some investments into infrastructure projects yielding 10 per cent or more.

Fortunately, with the proliferation of income trusts that invest in infrastructure, small investors can do the same thing.

There is no need to be stuck with the 60-40 split of stocks and bonds that many investment advisors advocate, especially if the big pension funds no longer think it is appropriate.

The reason that OMERS, which has $32 billion in assets and pays pensions to municipal workers in Ontario, has come to this decision is that it has been hurt by the combination of lower stock prices since 2000 and low returns on bonds.

It has gone from actuarial surplus to deficit in a short three-year period and it is now scrambling to make good on its obligations to pay inflation-adjusted pensions to future retirees.

Many private sector pension plans are in the same predicament. The expected future average annual returns of 7-8 per cent for stocks and 4-5 per cent for bonds will just not be enough to meet pension obligations.

For bonds, the historically high returns in excess of this level came from a 20-year trend of declining interest rates. Those high returns certainly will not be repeated, especially if interest rates rise in the next two years, which would lead to a decline in the value of most managed bond portfolios.

Given the pressures they face, OMERS and presumably other big pension funds are being attracted to direct ownership of real estate and infrastructure assets, such as roads, power plants, schools, nursing homes, etc. which often pay cash returns in excess of 10 per cent.

In effect, they want to own businesses and benefit from the cash flow being generated, rather than owning stocks and hoping the cash flow and profits raise the value of the stock holdings.

If individual investors want to follow their lead, there are a number of good infrastructure investment opportunities in the trust sector. The units are listed on the Toronto Stock Exchange and therefore eligible as Canadian content for RRSPs and RRIFs.

For example, in the energy field, AltaGas Income Trust (symbol ALA.UN) provides pipeline and gas processing services as well as delivery of electricity in Alberta. This is infrastructure just like roads or bridges. The trust is paying cash distributions at an annual level of $1.80 per unit. With a recent price for the units at $19.13, this represents a cash yield of 9.4 per cent.

In the power trust segment, Countryside Power Income Fund (COU.UN) has hydro and biomass electricity generating facilities. It is planning to pay an annual distribution of $1.02 per unit to begin with, for a present cash yield of 11.3 per cent.

There are several other power trusts available with cash yields in the 9 to 10 per cent range.

If an individual wants to invest in a hospital, albeit in South Dakota, he or she should take a look at Medical Facilities Corporation (symbol DR.UN) income participation units, which are expected to pay out a cash distribution of $1.10 per unit each year. At a recent price of $11.20, the yield on these units works out to 9.8 per cent.

Retirement REIT (RRR.UN) owns numerous retirement homes and long-term care facilities in Canada and the United States. With a projected $1.15 in annual distribution and a recent price per unit of $10.56, the cash yield amounts to 10.9 per cent.

Since earlier this year, the unit prices for many income trusts have come down, and cash yields have risen, in response to worries that interest rates will rise in the future and therefore make owning such trusts less attractive.

For most of June, however, unit prices for many trusts have edged higher as these fears were judged to be overblown, although some additional weakness may occur if interest rates rise more than is currently expected.

If that happens, however, it will mean an even better buying opportunity for individual investors who have done their research and are ready to add some cash-generating infrastructure to their portfolios.

Researching the trusts is very important. These trust are essentially operating businesses and nothing in business is guaranteed. That said, some of the trusts have good growth potential that could lead to higher cash distributions in the future.

Ironically, the big pension funds, despite their need for higher yields, will not likely be able to invest for the most part in the same trusts as individual investors. The federal government put a strict limit of 1 per cent of assets on pension fund investment in trusts in its budget earlier this year, although it later backed off on the implementation of the restriction until additional research is done. Itís uncertain what the election results will mean for this measure.

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. His columns are archived at and he can be contacted at

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©2004 Wayne Cheveldayoff