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New fund concentrates on income trusts with a history of increasing cash distributions

by Wayne Cheveldayoff, 2005-12-29

Many investors have been successful in achieving superior investment returns with a strategy of investing in stocks that have a long history of increasing dividends.

This same strategy is now being applied to income trusts in a new closed-end fund called the Payout Performers Income Fund.

The new fund, the first to adopt this strategy for income trusts, is being offered by First Asset Funds of Toronto and will be listed on the TSX.

The fund will only invest in income trusts that have a history of consecutively raising their annual cash distributions in each of the last five years or, for those operating less than five years but at least three years, consecutively raising their annual cash distributions in each year of operation.

The trusts must also have a market capitalization of not less than $300 million.

While there are approximately 113 income trusts listed on the TSX with a market capitalization greater than $300 million, only 20 income trusts presently have the cash distribution history to qualify for the Payout Performers Income Fund and the performance of this group of 20 in the past three years was a stunning average compounded total return of 48.77 per cent annually.

The average distribution growth rate of these 20 trusts is 45.71 per cent over three years, and the average payout ratio currently is 77 per cent.

With such a relatively low payout ratio, First Asset states in the prospectus (available at www.sedar.com) that this is a strong indication of the continued ability of these income trusts to meet their distribution targets and to deliver attractive total return potential for investors.

The indicative 20-trust portfolio cited in the prospectus includes 10 business trusts, namely Bell Nordiq Income Fund, BFI Canada Income Fund, Cathedral Energy Services Income Trust, CCS Income Trust, Consumers’ Waterheater Income Fund, Davis + Henderson Income Fund, Energy Savings Income Fund, Gateway Casinos Income Fund, Transforce Income Fund and Trinidad Energy Services Income Trust.

The oil and gas trusts that are included are Advantage Energy Income Fund, Bonterra Energy Income Trust and Focus Energy Trust.

Five real estate trusts make the list, including Calloway Real Estate Investment Trust, Canadian Real Estate Investment Trust, Cominar Real Estate Investment Trust, H&R Real Estate Investment Trust and Riocan Real Estate Investment Trust.

The two pipeline/power generation trusts that qualify are Altagas Income Trust and Transalta Power L.P.

The trusts will each have an equal portfolio weighting of 5 per cent initially and a rebalancing, with additions or deletions, is scheduled to occur in December of each year.

The indicative yield of this portfolio, after the payment of expenses, is 6.25 per cent annually, with cash distributions paid out monthly.

The annual management expense ratio (MER) of the Payout Performers Income Fund is expected to be about 0.95 per cent, made up of a management fee of 0.45 per cent, a “service” trailer fee to advisors of 0.30 per cent, and various other ongoing expenses of about 0.20 per cent.

This MER is well below the 2 to 2.5 per cent charged on traditional mutual funds specializing in income trusts where the manager applies his or her wisdom in picking the best trusts.

But the new fund’s MER is higher than a straight exchange-traded index fund, such as the recently introduced iUnits Income Trust Sector Index Fund (symbol XTR on the TSX), which tracks the S&P/TSX Capped Income Trust Index and has an MER of only 0.5 per cent per year. An index includes the largest trusts, whether they increased, held steady or decreased their cash distributions in the past three to five years.

As with all exchanged traded funds offered by prospectus, the dealer selling the fund receives a 5 per cent commission, which, along with other new issue expenses, comes out of the proceeds of the issue.

These expenses cause the net asset value (NAV) of the fund to initially dip to about 94 per cent of the issue price and it is the reason why many such funds trade below their issue price in the first months of existence. While an annoyance to those who bought the new issue, this situation also can represent an opportunity for other investors to pick up the units at a below-issue price.

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