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Correction in income trust market leads to buying opportunity

by Wayne Cheveldayoff, 2005-04-07

A buying opportunity is developing in the income trust sector where the unit prices of many trusts have fallen 10 per cent or more from their recent record highs.

Fears of inflation and higher interest rates are mainly responsible for triggering a sell-off in business, real estate and pipeline trusts.

Also, March saw a return to a more normal investment demand situation, as the large flow of money into the income trust sector during RRSP season subsided.

Among the trusts experiencing unit-price declines were waste hauler BFI Canada Income Fund, which by the end of March had dropped 15.8 per cent from its earlier record high.

On a peak to end-of-March basis, the decline for retailer Sleep Country Canada Income Fund was 16 per cent, Consumers Waterheater Income Fund 10.6 per cent, Gateway Casinos Income Fund 13.4 per cent, H&R Real Estate Investment Trust 11.1 per cent, Pembina Pipeline Income Fund 11.8 per cent and Enbridge Income Fund 11.1 per cent.

A correction was also underway by month-end for oil and gas royalty trusts. For example, the high-performing Peyto Energy Trust was 7.7 per cent off its high in sympathy with a correction in oil prices as U.S. crude inventories showed gains.

Based on how a similar correction played out in the spring of 2004, there could be more unit-price weakness for both energy and non-energy trusts in the coming month or so.

The 2004 sell-off in the income trust market had two installments, one in April and another in May, as fears of higher inflation and interest rates spread in stages through the market. Many trusts saw total declines of 15 to 20 per cent in unit prices.

The inflation fears and rate worries subsequently dissipated and the trust market fully recovered through the summer and fall of 2004.

Chances are that the same will happen in 2005.

The key reason is that the most likely economic scenario is the opposite of what is now feared. What is probable is that the recent spurt in inflation and economic growth in the United States, along with the talk of major rate hikes, will soon evaporate.

The U.S. Federal Reserve has been raising interest rates since last summer and probably will again in May. The higher U.S. rates, along with the higher oil prices, will eventually cut into U.S. economic growth. In Canada, with the economy already in moderate-growth mode and the Canadian dollar high, there really isn’t much danger of a major interest rate hike.

When the market realizes its worries of a major inflation and interest rate cycle are overblown, a recovery should occur for the business, real estate and pipeline trusts.

For oil and gas trusts, another down move could occur this spring as crude supplies climb in what is normally a seasonally low-demand period. But the longer-term fundamentals are still strong for oil and natural gas and, therefore, the recent pullback in the oil and gas royalty trusts is likely to be temporary.

Investors looking for bargains should focus on business trusts with good opportunities to grow their sales and cash distributions and also are holding back some cash to provide a cushion in case things go wrong. These are the trusts that are the least susceptible to interest rate hikes.

In the oil and gas sector, the most successful trusts are likely to be those that have the best exploration and development opportunities and are holding back enough cash to fund their capital investment plans.

One positive difference for income trusts compared with 2004 is that major pension funds will also be joining mutual funds and individual investors in the hunt for bargains. Two developments in the past year – Alberta and Ontario granting limited liability to unitholders and the inclusion of trusts, effective July, in the S&P/TSX composite index – will mean a broader interest in trusts on the part of institutional investors.

While above-mentioned factors favour an eventual recovery for trusts, it is not guaranteed. All bets are off if there is a sustained decline in crude oil prices below U.S.$40 a barrel, and/or a major spike in inflation and interest rates. So, as you identify attractive trusts and shop for bargains, keep an eye out for big-picture changes.

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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©2005 Wayne Cheveldayoff