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Trust kings fear fad will ruin reign

They're concerned Bay Street will pick ill-fitted businesses, ANDREW WILLIS finds

They should be on top of the world.

A handful of money managers reign supreme in the hottest market sector, income trusts. In a mutual fund world that has precious little to celebrate, these stock pickers boast 20-per-cent-plus returns and billion-dollar portfolios.

The masses are paying tribute to these results by throwing millions of dollars at the money managers every day.

Yet the kings of Canada's mutual fund empire all fret that their sector may become a victim of its own success. Uneasy lies the head that wears the crown.

The problem, in a nutshell, is that there's too much money chasing too few good trusts. Used properly, the money managers say high-quality trusts, also known as income funds, can goose extra cash out of companies, cash that can be passed on as income to an aging population.

The concern is that Bay Street, always quick to jump on a financing trend, will jam businesses ill-suited to the trust structure into the market. Think of your overweight uncle Buck at the beach, stuffed into a Speedo. A fad never fits everyone.

Ill-considered trusts will implode, blowing holes in portfolios and tarnishing the whole sector. Such a fate befell so-called structured products in the late 1980s.

Dealers fell over themselves to sell billions of dollars worth of these income-producing funds to retail investors, all keying off price swings in tech stocks. When the bottom fell out of the market, these funds lost their structure, to the dismay of investors.

"Our big challenge is ensuring the investment banks bring quality trust products to market," says Oscar Belaiche, who holds more than $1-billion worth of trusts in Goodman & Co. portfolios.

"There's probably 100 investment bankers at each of the six big brokerage houses who all know the trust market is the only market that can handle an [initial public offering]," says Ben Cheng, who oversees more than $1-billion in trusts for CI Fund Management. "They're busy slicing and dicing companies to find new trusts. My concern is we may have seen the best of the best, and approaching the point where the market is overheated."

The kings of the trust market portray themselves as benevolent rulers. They see their power being used to ensure that standards are raised, not lowered. Their clout is undeniable.

The size and newfound power of these mutual fund managers -- five key figures and another half dozen slightly smaller managers -- was unthinkable as recently as six years ago. In 1997, the income trust market barely existed. A few real estate and energy companies used the structure, successfully, but they were novelties.

So the late 1990s found Mr. Belaiche keeping an eye on the real estate holdings of a life insurer.

John Priestman, with close to $1.5-billion at Guardian Capital Co., was running conventional mutual funds. Sandy McIntyre, with $400-million at Sentry Select, worked on pension funds, and Paul Bloom, who now runs $1.4-billion, looked after just $150-million for wealthy clients of Bloom Investment Counsel.

These fund managers all faced the problem in the past few years -- how do you provide investors with double-digit income in an era of single-digit interest rates? Each concluded that trusts were the answer. They saw the potential of these tax-efficient, high-yield equities. Most other big investors steered clear, partly on concerns about potential legal liabilities.

"The bulk of the institutional crowd just flat out missed trusts," says Ira Gluskin, who holds about $200-million of the trusts in the $900-million portfolios at Gluskin Sheff & Associates Inc.

The handful of money managers who were in the game racked up strong results. Over a three-year period that saw the average Canadian equity fund lose 4.2 per cent, and the Toronto Stock Exchange benchmark down 11.1 per cent, these funds were all posting double-digit results, driven by trusts. Scotia Capital's trust unit index was up 23.9 per cent for the three years ended March 31, by far the best performance of any major asset class.

With strong performance to sell, money flowed in to the income funds -- anywhere from $100-million to $500-million a month. As assets grew, the fund manager's buying power shaped an emerging industry.

"You've got a handful of investors who hold about $15-billion worth of trust, they are doing their homework. They make or break deals," Mr. Gluskin says. "These institutions challenge the trusts and the dealers on issues such as long-term compensation schemes or governance."

These money managers buy, at most, one in four of the new trusts they are offered. They like to shop at new real estate investment trust (REIT) malls, check an energy trust's reserve life with outside consultants, wander the factory floor at a business trust and spend face-time with executives.

When the big money stands up to the Street, or trust management, they tend to win.

"The institutional managers can, and do, push for quality," Mr. Belaiche says. "Last year, the dealers brought out a raft of trusts based on U.S. businesses. We banded together in avoiding them, on fears that the IRS would change the U.S. tax treatment."

As a result of this boycott, which was also rooted in the price the American business owners were demanding for their offspring, most of the U.S. trusts never got off the ground.

"The mania is out of this market," Mr. Gluskin says. "You got a couple of small or speculative-type trusts that made it through, but in general, there's been good discipline."

For example, the big money managers all agree that restaurant trusts, gobbled up last year, wouldn't whet many appetites today. There were four such financings in 2002, a menu that included A&W burgers, Keg steaks, Boston pizza and East Side Mario's wings.

On the hot-button issue of compensation, the money managers say they've put a halt to gouging. A few years ago, executives running a business contained in a trust often demanded a big slice of any extra cash their company generated. Up to 50 per cent of any increase in distributable cash could go to managers as a bonus, money that came out of the unitholders' pockets.

"Some of the early incentive plans and buyouts of external management contracts amounted to legalized theft," says one fund manager, who asked not to be named. "I like to think we're growing a little more sophisticated on what we will and won't buy."

These days, performance bonuses are capped at about 20 per cent of the increase in distributions, and governance standards are "as good as the best of the public companies," says Guardian's Mr. Priestman. He adds: "We've sanded most of the rough edges off trusts."

The market can, and does, impose Darwinian standards on trusts. To grow, trusts must usually sell more units, and that's only possible if they perform. Citing long-gone and unlamented trusts such as Luscar Coal Ltd. as examples, he says: "Repeated managerial lunacy means no access to the capital markets. Management can't 'deworsify,' or vaporize shareholder capital through ill-timed share repurchase programs."

Mr. Priestman's favourite line on trusts is "what's not to like?" Occasionally, one of these businesses will blow up, as do companies in every sector. But the money management community's emerging expertise in valuing trusts, along with changes in the law, should win wider acceptability for these investments. That, in turn, should help ensure only higher-quality offerings make it to market.

John Priestman, Guardian Capital

Background: With Guardian since 1985, and his 25 years in the business includes stints with a major pension fund and investment dealer.

Assets: $8.1-billion

Trust holdings: $1.4-billion

What he likes: Canadian Oil Sands, RioCan, H&R REIT, Enerplus, Superior Plus

Ben Cheng, C I Mutual Funds

Background: U of T Commerce grad, 12 years experience at four fund managers including the last six years at CI.

Assets: $31-billion

Trust holdings: $1-billion

What he likes: RioCan, ARC Energy, Enerplus, Davis + Henderson, SFK Pulp Fund

Sandy McIntyre, Sentry Select Capital

Background: After 20 years at Jones Heward Investment Management, now part of Bank of Montreal, he joined Sentry Select three years ago.

Assets: $1.5-billion

Biggest trust holdings: $1.3-billion

What he likes: ARC Energy, Canadian Oil Sands, Fording Coal, Algonquin Power, Energy Savings

Oscar Belaiche, Goodman & Co.

Background: At Goodman & Co. since 1997, his 20 years in investment included running Prudential Insurance's Canadian real estate portfolio.

Assets: $8-billion

Biggest trust holdings: $1-billion

What he likes: Bell Nordiq, Canadian Oil Sands, CCS, Clearwater Seafoods

Paul Bloom, Bloom Investment Counsel

Background: A British lawyer, he left merchant banking in 1985 to set up his own firm, and now runs seven trust-focused Citadel funds.

Assets: $1.4-billion

Trust holdings: $1.4-billion

What he likes: ARC Energy, Fording, Retirement Residences REIT, Davis + Henderson

A matter of trust


How trusts are transforming Canada's equity markets

It's all about tax

Foreign ownership


The Kingmakers

Is the TSX still relevant?

The business trust boom


Reliable REITS

Management fees can be key


It all started with energy

Reserve committees a sign of maturity


An investors guide

Decoding a prospectus


The funds of trusts

Read the series so far at

© 2007 The Globe and Mail. All rights reserved.

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