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New ‘Tracker Fund’ set to catch the upside as income trusts are added to Canada’s premier stock index

by Wayne Cheveldayoff, 2005-06-02

A new Brompton closed-end income trust fund, called the Tracker Fund, offers investors an opportunity to profit from the inclusion of income trusts in the S&P/TSX Composite Index.

The fund will invest in income trusts that are expected to be included in the overall composite index beginning in December, according to a prospectus recently filed by Toronto-based Brompton BTF Management Limited (www.bromptongroup.com).

As income trusts are added to Canada’s premier equity index, they are expected to gain in value as large amounts of trusts units are bought by index-minded pension funds and other institutional fund managers.

There is a degree of speculation involved on Brompton’s part, as S&P won’t announce until September which income trusts will be included.

But by being first in, so to speak, to buy the 60-odd largest and most liquid trusts that are likely to be included, Brompton expects to be able to capture a good part of the increase in value that could come from institutional investors joining the party.

The trusts likely to be included (which are listed in the prospectus and can be viewed at www.sedar.com) had an average current yield of 8.8 per cent as of the end of April.

Individual investors, along with some mutual funds, have been the major investors in the income trust sector so far.

There has already been some anticipatory buying by institutions but a lot more is likely when institutional investors start getting serious about it.

Once S&P makes the list official, Brompton will adjust its holdings to exactly match up with those included in the index.

This will make the Tracker Fund a true index-linked fund. In fact, Brompton is the first to roll out a fund that will track the income trust sub-segment of the S&P/TSX Composite Index. While other fund companies are likely planning something, this is not yet a crowded field.

Barclay’s Canada previously introduced a fund that tracks the existing S&P/TSX Capped Income Trust Index, although the linkage is through a swap agreement rather than a direct investment in income trusts (as in the case of the Tracker Fund).

The Middlefield Group has an ‘IndexPlus’ fund, of which a portion is invested according to the existing S&P/TSX Capped Income Trust Index and the remainder is actively managed.

One advantage of the new Tracker Fund is its low annual management expense ratio (MER), which is expected to be around 1 per cent and perhaps even as low as 0.85 per cent if the fund tops $100 million. Most other closed-end funds charge in the 1.5 to 2 per cent range.

The fact that the Tracker Fund is an index-linked fund means the fee going to managers is lower, since they do less work. It will be 0.45 per cent annually, which is well below the usual 1 to 1.25 per cent charged for actively managed funds.

Also, Brompton has shaved down the trailer fee going to the selling agent (financial planner or investment advisor) to 0.3 per cent annually, whereas the usual trailer fee on closed-end funds is 0.4 per cent.

One thing for investors to keep in mind is that such closed-end funds that are issued via initial public offerings and trade on the TSX work out a lot different than regular mutual funds when it comes to commissions. On closed-end funds, advisors get an initial 5 per cent selling commission that comes out of the funds put up by investors. In addition, there are “expenses of the offering” which could add another 1.5 per cent.

What this means in practice is that when the deal is complete and before any of the funds are invested in income trusts, the net asset value of the fund immediate drops by as much as 6.5 per cent; a $10,000 investment by an individual would be worth only $9,350 to start with.

It’s the way business is done on Bay Street and it means that investors should think of these funds as longer-term investments, or they should perhaps wait until the fund starts trading and see if it can be purchased in the secondary market at a price closer to its true net asset value after commissions and expenses are incurred.

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 www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.



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©2005 Wayne Cheveldayoff