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Q1/6 Focus on ETFs
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Q1/2 PH&N Cdn Equity
Q1/2 Mawer U.S. Equity

Thrifty Trusts
Saxon High Income Fund

With interest rates at historic lows income trusts have been touted as a good alternative for yield-starved fixed-income investors. However, picking an income trust can be trickier than picking ordinary stocks, and as with other investments it is best to hold a diversified portfolio of trusts. It should come as no surprise that mutual fund companies have recently sought to capitalise on trusts' popularity by offering income trust funds. But before getting to the funds, it is appropriate to review some basics about income trusts.

In brief, an income trust serves to channel pre-tax cash flows from a company's operations to the trust's unitholders. Sure there is income, but any comparison to traditional fixed-income instruments pretty much ends there. The most common income trust structure has the trust itself acting as a middle-man between unitholders and some underlying business. In one common scheme, the trust sells units to outside investors and then lends cash to the underlying business. In return, the underlying company makes interest payments to the trust. Typically, the interest rate on the loan is such that after making payments the company is left with very little net income and ends up having a vanishing tax liability. Since interest is paid out of pre-tax income, distributions are taxed only once at the unitholder's tax rate. This is in contrast to the situation with ordinary corporate dividends, which are paid out of after-tax earnings. The expected net result is higher income for trust unitholders.

However, if a company pays out most of its income then it has little residual capital to expand and grow. Furthermore it is much more difficult for such a company to weather an economic downturn, which could potentially wipe out its distributable income. For this reason an income trust's underlying business frequently involves a mature business in an industry characterised by predictable cash flows. The main point here is that income trusts still carry all the business risk associated with corporate stocks. More in-depth discussions of the merits and risks of income trusts can be found on a number of websites.

The following sites are good starting points:


There are currently fourty-four Canadian income trust funds listed on, including fifteen pooled or segregated funds. Only eleven of these funds have been around for at least five years. The oldest is the now closed Bissett Income-F fund, which was launched in June of 1996. As of August 31st it had a five year average annual return of 18.5%, which puts it just shy of first place in its asset class. The group average performance for income trust funds was 14.7% annually over the same period.

The average management expense ratio (MER) charged by the twenty-nine open-ended income trust funds is about 2%. This is lower than the median 2.6% MER for equity funds but higher than the 1.6% median MER of bond funds. When buying equity funds, investors' long-term interests are best served by seeking funds that charge an MER of no more than 2%. Since income trust funds are fundamentally equity instruments that are closer in spirit to dividend funds, you should expect to pay less than for an equity fund. An upper MER cutoff of 1.8% seems reasonable. Focussing only on income trust funds with a track record of at least five years, only the Saxon High Income, Bissett Income-F, and CI Signature High Income funds meet this criterion. In what follows I focus on the Toronto-based Saxon High Income fund, which charges a very modest 1.34% MER.

Saxon High Income

During the first nine months of the year the Saxon High Income fund enjoyed a return of 11.1%, slightly underperforming the S&P/TSX Composite Total Return index, which posted a return of 13.9%. Its five year average annual return as of September 30th was a healthy 12.5%. This compares very favourable with the Composite's 7.4% performance and the Scotia Capital Markets Universe bond index's 6.6% average annual return. Income distributions for the trailing twelve months totalled $0.78 per unit, or just over 7% of the last reinvestment price.

The fund is managed by Rick Howson of Howson Tattersall Investment Counsel. Just like all the Saxon funds (, the High Income fund's investment style is value-based. More specifically, the fund takes a bottom-up approach considering trusts that have a strong balance sheet, not too much debt, and growing distributions while still maintaining a comfortable margin of safety in terms of retained income. Particularly valuable to Mr. Howson is the ratio of enterprise value to earnings before interest, taxes, and depreciation (EBITDA). Prospective purchases for the fund have a ratio of no more than nine.

The types of underlying businesses favoured by the fund are those which own long-term or non-depleting assets. These can include manufacturing facilities and power plants, for example, in contrast to the depleting assets of, say, the oil and gas sector. Although the fund is biased towards these types of businesses, its bottom-up nature means that solid but undervalued resource trusts will still be purchased by the fund. At the end of the 3rd quarter the fund held 56.7% of it assets in the consumer, industrial, and utilities sectors. In contrast, the Scotia Capital Markets Income Units index, which reflects the broader trust sector, had over 62% of its weight in oil and gas, resources, and real estate trusts (REITs).

Mr. Howson typically likes to hold at least fourty different income trusts in the fund to ensure a well-diversified portfolio. Once purchased, a trust is held until it is deemed to have reached a too high valuation level. According to Mr. Howson this generally translates to a holding period of four to five years. Adverse changes in a company's fundamentals could, of course, also prompt a sell decision. The fund's low 24% average turnover reflects this long-term approach.

At the end of June the fund held fourty-nine distinct income trusts and six stocks, making up 88.3% of the fund's assets. A further 7.2% was held in corporate bond issues and it held a 4.5% cash position. The fund's top three holdings were the Associated Brands and PRT Forest Regeneration income funds, and the Canadian Hotel Income Properties REIT. During the 3rd quarter Calpine Power Income Fund was added to the portfolio. Calpine Power owns and operates a number of power plants in Canada.

About 16% of the fund's holdings involve U.S. based businesses. The recent decision by PriceWaterhouseCoopers to quit auditing the U.S. based Specialty Foods Group Income Trust highlighted the uncertain legal status of some of these trusts. Currently, the IRS allows cross-border trusts to deduct interest payments on their debt. Were this to change then companies' taxes would rise and distributions to unitholders would drop. Mr. Howson points out that this issue is not specific to income trusts and has been around for many years. He also states that for these reasons he is not at present overly concerned about the situation but does acknowledge that this issue could have an impact on the fund's future investment decisions.

Going forward, Mr. Howson feels that the income trust sector should continue to provide strong single digit returns in the 7%-9% range. This projection is based on a continued low interest rate environment, an expected pickup in the economy, and sustained demand for trust units. For a modest $5000 minimum investment the Saxon High Income fund can be purchased directly from Saxon Mutual Funds in Ontario or through brokers and dealers in other provinces.

With a low 1.34% MER, no load fee, and a solid track record, the Saxon High Income fund is suitable for more adventurous frugal investors who seek greater income than that available from traditional bonds and GICs. It is best held as a part of the equity portion of a well-balanced portfolio. It may also be suitable as a substitute for dividend funds or riskier high-yield bond funds.

No matter the asset class, frugal investors should stick with mutual funds that charge low fees and, if necessary, buy load funds through a discount broker who will waive the load. Over the long term your savings will add up and help to ensure that more of your money keeps working for you.

Carl Wolfe, PhD

November 2003



Disclaimers: Consult with a qualified investment advisor before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...