DANGER SIGNALS FOR INCOME TRUSTS

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  I have a warning for you this month. It concerns income trusts, which have been enjoying a new surge in popularity recently as investors seek out alternatives to the low interest rates being offered by bonds, GICs, and other fixed-income securities. Be very wary about making new investments in these securities. We could be heading for a big drop in market values, similar to what we saw in 1998.

I say that despite the jump today in the price of many of the energy trusts, such as Pengrowth, Freehold, and Canadian Oil Sands. That move is in response to Iraq’s announcement that they are cutting off oil exports for 30 days in protest against Israel’s continued military action in the West Bank. Despite the enmity that exists between the U.S. and Saddam Hussein, the irony is that the United States indirectly takes most of the oil that Iraq exports. So the boycott is likely to hit them hardest. Oil prices in New York jumped as soon as the news came through.

This provides a temporary boost to the energy trusts, and if other Arab countries join in that effect will be magnified. However, it will only be temporary and will affect one type of income trust. When you look at the overall picture, it doesn’t look bright.

There are several reasons for my concern:

1) A flood of new issues. We haven’t seen so many new income trust IPOs in several years. The market is being saturated, and some of the newcomers are of questionable quality.

2) Rising interest rates. The market price of many trusts is directly affected by rate movements. When rates head up, investors demand higher yields from these trusts to compensate for the risk they are taking on. Unless profits can rise fast enough to keep pace, the market price has to drop to create a higher yield.

3) Overpricing. The whole income trust sector has done very well in the past couple of years. While stock markets wallowed, investors in many of these trusts won on two counts: high cash distributions and capital gains. But now many of the trusts look expensive. One prominent fund manager estimates that real estate investment trusts are currently 20% overvalued, while some other trusts are 30% overpriced.

The solution: Review all your income trust holdings carefully. If you are heavily exposed in this area, consider doing some pruning and taking some profits.

Good alternative: Instead of buying trusts individually, invest in a well-managed fund that specializes in this area. By doing do, you achieve broad diversification, which will reduce risk. Best bets: Guardian Monthly High Income Fund, Renaissance Canadian Income Trust, and the closed-end Citadel Diversified Investment Trust that trades on the TSE under the symbol CTD.UN.

There’s a detailed write-up on the Citadel fund in the April 8 edition of our Internet Wealth Builder newsletter. For membership information: http://www.buildingwealth.ca/Newsletter/index.cfm

TOUGH TIME FOR BONDS

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  Rising interest rates are not only bad news for income trusts. Bonds are also adversely affected. In fact, we’ve already seen bond prices pull back in anticipation of higher rates later this year, even though the central banks have yet to make a move. Most bond mutual funds lost money over the past month, with declines in the 1%-2% range in many cases.

But there has been one bright spot: the high-yield bond category. It’s been running against the tide, with some funds up more than 2% in the past 30 days. Reason: High-yield bonds (better known as junk bonds) are not as interest-rate sensitive as government issues, and respond better to improving economic conditions because the risk of default is seen to be diminished. That makes them a good alternative for part of the fixed-income section of a portfolio during conditions such as we are currently experiencing.

My long-time favourite in this category is the Trimark Advantage Bond Fund, offered through the AIM Funds organization. This well-run fund possesses the best five-year average annual return in the category, at 5.9% (to Feb. 28), and has produced an average annual gain of just over 9% for investors since it was launched in December 1994. Especially significant is the fact this fund has never recorded a losing calendar year and has a risk rating that is much better than average for the category.

However, this is not a pure junk bond fund. The managers, led by veteran Patrick Farmer, maintain a core holding of government securities to reduce risk and provide a cushion when high-yield markets turn sour. So this fund will not do as well as a 100% junk bond fund when times are good, but it will protect your capital more effectively when things are tough.

If you need regular income, there’s another feature you’ll like: the fund pays monthly distributions, which average out to slightly more than $0.03 a unit. It’s a good choice for a RRIF because of the steady cash flow and below-average risk.

Note: This commentary was adapted from the April issue of Mutual Funds Update, a monthly newsletter that provides guidance on choosing the best funds and building a winning portfolio. For subscription information: http://www.buildingwealth.ca/mfudemo.cfm

SMALL CAPS LOOKING STRONG

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  The major stock market indexes are struggling to keep their heads above water in 2002. But almost unnoticed, small cap stocks have been doing very nicely, thank you. While the blue-chip S&P/TSE 60 Index showed a year-to-date drop of 0.4% to the market close on April 5, the S&P/TSE Small Cap Index was up 9.8% for 2002. If you don’t have any small cap positions, you’ve been missing out.

The problem with choosing small cap stocks is that they tend to be more volatile than the big companies. An added complication is the difficulty in finding dependable research material about them. Most small companies are not on the radar screens of the analysts at the big brokerage firms.

Here again, the best solution for the average investor is a top-notch small cap mutual fund. You won’t find one much better than the little-known Saxon Small Cap Fund. I’ve been praising its virtues for years in the annual Buyer’s Guide to Mutual Funds, but few people seem to pay attention. The fund has total assets of only $60 million, which makes it a midget in the investing world.

What are you missing? How about a one-year return of 30% to Feb. 28? Could your portfolio have used that? Readers of Mutual Funds Update have benefitted; we added the fund to our Recommended List last July.

Another big advantage is relatively low risk. Even though it’s theoretically in a higher risk category, this fund has never lost money in a calendar year since at least 1994.

Added bonus: Ontario residents can buy units directly from the manager on a no-load basis. Call 1-888-287-2966. In other parts of the country, check with your broker for availability. Many now offer it.

The one big negative: you’ll need $5,000 to take an initial position.

AGF SHOCKER

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  Many investors were shocked when the news came out that the Charles Brandes organization is resigning as manager of the widely-held AGF International Value Fund and two other AGF entries. The company is still scrambling to find a replacement.

We sent out immediate advice to readers of the Internet Wealth Builder and Mutual Funds Update, and have revised the rating for the funds on our On-Line Mutual Funds Database.

For general guidance on how to proceed in this kind of situation, check out my audio commentary on our Mutual Fund Minute feature at our Web site. You can find it at: http://www.buildingwealth.ca/MFM.cfm

THE TAXATION OF JOINT ACCOUNTS

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  With the tax filing deadline looming, many people are getting down to the nitty-gritty of their returns. One question that I’ve been getting concerns how to declare the interest from joint accounts. Read the answer on our Q&A page at http://www.buildingwealth.ca/qa.cfm

Other questions this week deal with claiming capital losses, where to invest short-term money, and an explanation of the concept of beta.

A FUND MANAGER UNLIKE THE OTHERS

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  There’s a little-known mutual fund manager who consistently produces great returns for his investors. And when he doesn’t, guess what? He reduces his fees! When did you ever hear of anything like that? To read the full story: http://www.buildingwealth.ca/News/Featuredetails.cfm?NewsletterID=1046

TOP STOCKS SOARS

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  We’re delighted to report that response to our recently-launched newsletter, TOP STOCKS, has been overwhelming. We are now closing fast on 1,000 subscribers in just two months. The comments we have been receiving have been very positive. “Very informative yet easy-to-read writing style,” wrote H.S. from Ontario.

Our selections have generally performed well thus far, even in these volatile markets, with several showing nice gains.

If you haven’t signed on yet for this high-quality, low-cost monthly e-mail newsletter, you can do so now at a saving of 20% off the regular price. For a limited time, we’re offering a one-year subscription to TOP STOCKS for just $23.95 plus tax. For details: http://www.buildingwealth.ca/bookstore/productdetail.cfm?product_id=300

RRIF BOOK OFF THE PRESS

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  If you have money invested in a RRIF or LIF, or will be opening such a plan soon, you’ll want to own a copy of my new book, The Complete Guide to RRIFs and LIFs. It has just come off the press in a hard cover edition, published by Prentice Hall Canada. My co-author is David Tafler, editor and publisher of CARP Fifty-Plus magazine and one of the country’s leading experts on retirement planning.

For more details and to order a copy at 25% off the suggested retail price, go to: http://www.buildingwealth.ca/bookstore/productdetail.cfm?product_id=296

MONEY-SAVING PACKAGES

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  Many people have been asking us to put together package offers for our products that would reduce the cost for those buying more than one of our services. We’ve responded with our new Bronze, Silver and Gold Investor Specials. If you’re a serious investor, I’m sure you’ll find one that is tailored to your specific needs.

For the details, go to our Home Page at http://www.buildingwealth.ca and check our Bookstore special offers for April.

That wraps up this edition of Investing Today. As always, please forward a copy of this issue to anyone you think might be interested. If you have received this copy from someone and would like to be on our regular distribution list, go to http://www.buildingwealth.ca and click on the Investing Today banner to sign up. It’s a free service.