Canadian Income Trusts -- Super Income Investments

Although many Canadian income trusts are terrific investments that pay a high yield, they are not risk-free . . . "investor beware" is always a good slogan before you pay for any type of security.

The risks of Canadian royalty trusts include:

1. Business risk -- they can have all the ups and downs of any business.

2. Political risk -- the current government wants to end their tax-free status.

3. Pricing risk -- many oil and other commodity trusts make more or less money depending upon world oil and commodity prices.

4. IPO/Reorganization risk -- not every corporation should convert itself into a trust. Sometimes what unitholders are buying is a shell game that benefits the corporate officers at their expense.

5. Return of capital risk -- some business trusts pay out more in dividends than they take in from their operations. This is not sustainable in the long run.

You can attempt to reduce these risks by buying only Canadian Royalty trusts rated highly by Standard & Poor's and DBRS (formerly Dominion Bond Rating Service) for stability of distributions.

However, let's face it -- this is public knowledge that's already factored into the market price of trusts.

I can't cite any academic studies, but my bet is that the market for Canadian income trusts is just as efficient as that for stocks. Therefore, all the advice to do your "due diligence" when you buy Canadian royalty trusts is just a cop-out --

You can't predict which income trusts are going to outperform the market . . . so, what to do?

I suggest buying only those trusts which are included in the Mergent Canadian Dividend Achievers index.

This list includes all Canadian companies (business trusts, real estate investment trusts and corporations) which have increased their dividend payout for at least the past five years. Those companies that cannot manage their businesses well enough in the long term to reward their owners with annual dividends increases . . . don't make this list.

I'd advise you to buy the exchange traded fund that tracks this index but, unfortunately, there is none -- yet. If you learn of one, please let me know.

What are Canadian income trusts -- explains the basics of how these trusts are structured, and the advantages this gives them under Canadian tax law, until 2011.

What's the difference between a trust and a corporation -- the difference between trusts and corporations. It makes no practical difference to investors, except that until 2011 Canadian laws make trusts tax-free if they distribute 90% to unitholders. Corporations must pay taxes.

Kinds of Canadian income trusts -- various kinds of businesses have converted into trusts, though energy and natural resource companies are the prime ones.

What are the risks of Canadian income trusts -- all businesses come with risks, and some with special kinds. Canadian business trusts have fallen victim to political risk.

Enerplus Resources Fund -- one of the biggest and best Canadian trust.

2011 is now just four months away. The Canadian government has not backed down from its policy that starting next year Canadian trusts will have to pay taxes (with the exception of real estate income trusts). Trusts are converting themselves into corporations. What can income investors do?

If you already own them, just hang on, assuming they continue to pay dividends. Their payouts may go down, because they're paying taxes to the Canadian government, and that's unfortunate, but if you sell them you'll have to pay capital gains taxes and then buy another income producing investment with what money remains. So you may as well stick to the income investment you already own.

If you haven't bought any yet, there's no particular reason now to start. As a category of income investment, they're about to disappear.

That doesn't mean you should totally ignore Canadian companies that pay dividends. It just means that former Canadian trusts will simply be corporations that pay dividends. They're worth owning if they continue to raise their dividends. I let the Mergent company track this.

If you're in the United States, consider buying Master Limited Partnerships. These are publicly traded limited partnerships in the energy and natural resources sector. Most of them are midstream oil companies. They get paid for transporting crude oil, natural gas and refined petroleum products. They too must pay out at least 90% to their limited partners, so they have great cash flow. You can learn more from my book on them: Master Limited Partnerships, available from Amazon.