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New closed-end income trust fund offers broader diversification and lower fees

by Wayne Cheveldayoff, 2004-10-07

Investors in mutual funds specializing in income trusts may want to compare what they own with a new Barclays Canada fund containing the top 100 income trusts and offering a very low annual management fee.

The fact that Barclays is able with its new closed-end fund to offer a management expense ratio (MER) of just 1 per cent may cause some soul searching for those holding actively managed mutual funds with MERs in the order of 2 per cent or more.

Is it worth paying annual fees of at least 1 per cent more for active management?

There is no set answer to this question. It depends in part on personal preference. Some people sleep better if they know a portfolio manager is watching things, whether or not that results in better performance.

On the question of fund performance, there is not much one can say with certainty about the future. Historical evidence suggests that an equity fund (income trusts are equities) can do better than the general market for a year or two but very few funds can outperform in the longer term.

Can active managers, through trading and smart portfolio selections, add at least 1 per cent a year in return over the long-term? One would think they could, given it is their full-time job.

Nevertheless, despite their skills, experience and timely access to information, every year there are active managers who underperform the general market.

What does an investor get from buying the closed-end Barclays Top 100 Equal Weighted Income Fund and paying the lower 1-per-cent MER?

One feature of the Top 100 fund is that it offers a broader exposure to trusts than available elsewhere. Most active managers have fewer than 100 trusts in a portfolio (its hard for anyone to follow that many). The S&P Capped Income Trust Index, which is the basis for past closed-end index-related fund offerings from Barclays and others, reflects the performance of 62 trusts.

While as of the end of August there were 152 distribution-paying income funds listed on the TSX, the ones to be included in the Top 100 represented about 92 per cent of the total approximate $90 million market capitalization. Those not being included in the Barclays fund are quite small, with market capitalizations generally under $200 million.

The “equal-weighting” feature means that each trust in the portfolio, no matter how large its market capitalization, makes up only 1 per cent of the portfolio. By contrast, in an index-linked or actively managed portfolio, a single trust could make up 5 or 7 per cent of total holdings. With only 1 per cent of the Top 100 portfolio exposed to any one trust, the hit to the portfolio’s value of a bankruptcy would be much less.

Equal weighting also reduces exposure to the large-capitalization oil and gas royalty trusts, which have performed well in recent years but may not in the future if oil and gas prices tumble. On the basis of market capitalization alone, the energy trusts make up 46 per cent of the largest 100 trusts, but the equal-weighting feature in the Top 100 reduces this to 34 per cent.

Aside from energy trusts, the Barclay fund will also have positions in real estate investment trusts, pipeline and utility trusts and business income trusts.

The Barclay’s preliminary prospectus (available under public companies at says that had its Top 100 fund existed and had been fully invested on August 31, 2004, it would have had an annual yield of 8.3 per cent (assuming an offering the size of $100 million and that the fund had borrowed and invested 10 per cent of the value of its assets as it is permitted to do and taking into account all fees and expenses).

The prospectus notes that based on publicly available information, it is estimated that at least 35 per cent of the distributions paid by the fund in 2003 would have been characterized as a return of capital. Such return of capital is not taxed immediately like income, interest or dividends but reduces the adjusted cost base of the investment and is taxed later as capital gains when the fund is sold.

In contrast to mutual funds that invest in income trusts, the Barclays closed-end fund will trade on the Toronto Stock Exchange where it joins several other closed-end funds with income trust holdings offered by Barclays (see and other fund companies – most with very reasonable MERs.

For example, Middlefield’s IndexPlus Income Fund – brought to market in 2003 – offers a return based 70 per cent on the S&P/TSX Capped Income Trust Index and 30 per cent on active management. Its approximate 1.2-per-cent MER, as noted in its prospectus, breaks down as follows: 0.6 per cent for the manager; 0.3 per cent as a trailer fee to the investment advisor; and 0.3 per cent for expenses (assuming issue size of $100 million).

In the Barclays Top 100 fund, the fee to the manager is trimmed to 0.45 per cent (since there is no active management), with the remaining portions of its estimated 1-per-cent MER being 0.3 per cent for a trailer fee and 0.25 per cent for general expenses.

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