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The all-Canadian trust guide
the top 100 Canadian income trusts


It's time to grab a cold drink and dream of raking in loads of income while retiring on the beach. There's only one hitch - it's darn hard to find dependable, high-yield investments these days. Government bonds provide only a trickle of cash, while most stocks pay meagre dividends.

So what's a yield-hungry investor to do? Over the past few years the answer has been to flock to the generous payouts offered by income trusts. What makes this burst of popularity all the more remarkable is that only five years ago, many investors had never heard of trusts. Even today many people who have stuffed their portfolios full of them would find it difficult to define exactly what an income trust is.

Income trusts get their name because they were originally developed to hold income-producing assets in trust for investors. While many variations have since evolved on that simple theme, the basic idea still holds true. A trust operates a business, a real estate portfolio, an oil well, or a public utility in much the way a standard corporation would. But unlike corporations, which must pay tax on their income, trusts pay out most of their profits as "distributions," which avoid corporate taxes. As a result, income trust investors receive fat distributions that are then subject to personal taxation.

Thanks to their ability to spin off cash, trusts have gone on a tear in recent years. Part of their new-found popularity is the result of falling interest rates. As yields on GICs and bonds have plunged below 5%, the higher yields from many income trusts have attracted investors like moths to a flame. Also important has been rising commodity prices, which have propelled the cash flow at many natural resource trusts into the stratosphere. As a result, the median income trust has gained an eye-popping 17.8% annually over the last five years; only a few trusts had the temerity to actually lose money.

But what comes next? While trusts have enjoyed a great bull run, one worry is that the rush of money into the field has encouraged the formation of many new trusts that aren't always of the highest quality. In some cases, those trusts are wooing investors with the promise of high initial yields. The question is whether those yields can be maintained in years to come. Another worry is whether investors are now paying so much for trusts that they're doomed to disappointment in the years ahead, as prices settle back to more sedate levels.

To help you assess the risk involved in selecting individual trusts, we've dug deep into the sector and graded Canada's top 100 trusts on their ability to provide healthy dividends for a reasonable price. Although we've used some high-powered math to arrive at our ratings, the results can be understood by anyone who's ever read a report card. Top-of-the-class trusts earn an A. Solid but unspectacular stocks get by with a B or a C. At the other end of the spectrum, bottom-of-the-heap prospects go home with a D, or even an F.

Before stringing up your retirement hammock, we should emphasize that we're not saying that you can make a fortune by buying every A trust and dumping every F trust. The market just isn't that predictable. But we do think A trusts deserve your attention. They have the ingredients for success over the long haul. On the other hand, you'd better be careful when it comes to bottom-of-the-class trusts. While no one can predict how they'll perform over the next few months, they don't strike us as the shiniest prospects for the long term.

We stress that our grades are based purely on the numbers. We didn't factor in our personal opinions about a sector or a specific trust. Instead, we scoured the Thomson Baseline database, which provides background financial information on all sorts of trusts. We restricted our ratings to Canada's largest trusts by market capitalization, then trimmed the initial list because some trusts have been around for less than a year or lack the robust cash flow data we need for detailed analysis. Finally, we doled out marks based on three objective criteria:

Yield: No surprise here - the more money a trust puts in your pocket, the better. We gave high marks to any trust that yields more than 5%, since that payout is greater than what most government bonds and many corporate bonds deliver.

Reliability: We like it when a trust is paying a high yield, but we like it even more when we feel confident that the trust's underlying business is in good shape and that it can continue to pay its distribution for the foreseeable future. To ensure our top-rated trusts were operating with a cushion of safety, we awarded high marks to trusts that pay out less in distributions than they generate in cash flow from operations.

We gave trusts additional marks if they used low amounts of debt, since low debt reduces a trust's financial risk. (We measured each trust's reliance on debt with a so-called leverage ratio, defined as the ratio of total assets to unitholders' equity.)

Finally, to make sure we weren't recommending trusts in steep descent, we awarded top marks to trusts that showed relatively stable or growing book value per share. Our reasoning here was simple: we like trusts that can grow their business much more than those headed for the boneyard.

Value: We awarded the highest marks to trusts trading at low prices in comparison to their cash flow. We measured this a couple of ways, because while we wanted low price-to-cash-flow ratios in an absolute sense, we also wanted a trust's price-to-cash-flow ratio to be low based on its own five-year history. By using both an absolute and a relative measure of cheapness, we rewarded trusts that provide lots of cash flow for a reasonable price, and also rewarded trusts that have been around for at least five years.

Putting our marks together we arrive at final grades for each of our 100 trusts. Only two managed to earn an A, but 12 managed a solid B. We think both classes are well worth your consideration as investments. Don't get too caught up in which trust got an A and which got a B - because we reserve the very best marks for trusts with lots of data and a long history, we expect that as the trust market matures some of the B and C trusts will join the A list.

Top of the class
Name Grade
Advantage Energy Income Fund (AVN.UN) A
TransCanada Power (TPL.UN) A
Acclaim Energy Trust (AE.UN) B
APF Energy Trust (merged)B
ARC Energy Trust (AET.UN) B
Chemtrade Logistics (CHE.UN)B
Contrans Income Fund (CSS.UN)B
Enerplus Resources (ERF.UN) B
Fort Chicago Energy Partners (FCE.UN)B
North West Company Fund (NWF.UN) B
Peak Energy Services Trust (PES.UN)B
Petrofund Energy Trust (PTF.UN) B
Shiningbank Energy Fund (SHN.UN) B
Viking Energy Royalty Trust (VKR.UN)B


Before buying on the basis of our grades, you should make sure the trust's situation hasn't suddenly changed in some important way. Be sure to read the firm's latest press releases, its regulatory filings, and recent newspaper stories to get up to speed on all the most recent developments.

Remember, too, that interest rates matter. Like bonds, income trusts tend to go down in price when interest rates rise and go up when interest rates fall. If the long era of falling interest rates is nearing an end, as many observers expect, trust prices and bond prices could both take a beating. That's why it's wisest to maintain a diversified portfolio and not just load up on high-yielding trusts.

The best way to use our grades is as a starting point for your own research. And don't feel confined by our approach. Instead, look up the characteristics that mean the most to you. If you're interested in trusts with a high yield and low leverage, it's a simple matter to grab a pencil and underline a few prime choices. Like any screening strategy, the purpose of our trust ranking is to help you distill a sea of data into a few good ideas, which can then be investigated in more detail.

Click here to download an Excel spreadsheet of the All-Canadian Trust Guide.

From the Summer 2005 issue.
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