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For some fund managers, the trust glass is half-full

While some people keep railing on about the federal crackdown on income trusts, mutual fund manager Cecilia Mo is running around with a shopping list.

Since the Oct. 31 announcement that trusts will be taxed starting in 2011, the manager of the top-performing Fidelity Income Trust Fund has been nibbling at such names as Aeroplan, Cineplex Galaxy, CML Healthcare, Golf Town and Yellow Pages.

"In the next six to 10 months, there are going to be lot of interesting buying opportunities," she said yesterday after a presentation to investment advisers in Ottawa.

It's one thing to be angry at the Conservative government for breaking its promise not to tax trusts. It's another to spend all your time fulminating and none on adapting to the new trust reality like Ms. Mo, whose fund is a top performer in the Canadian income trust category with a year-to-date gain of 4.6 per cent.

For example, she's not holding out much hope that Ottawa will alter its trust decision. "It looks like it's a done deal, despite all the campaigning."

Some investors are focused on the decline in the dollar value of their trust holdings, even while these trusts continue to pay out monthly or quarterly income. Ms. Mo discounts the possibility of a huge rally in trust prices and sees more of a zigzag trading pattern in the months ahead.

The message here for investors is that their trust holdings won't spring back to Oct. 31 values, but they may be able to make up some ground with shrewd buying of trusts or trust funds in the months ahead.

What to buy? Ms. Mo isn't too keen on real estate investment trusts, which were spared the new trust tax and as a result have become a pricey haven for investors. For a few reasons, she's also not much interested in energy trusts.

While she does hold a few energy trusts in her fund -- Canadian Oil Sands, for example -- she thinks they're too pricey still in relation to the risks in holding them. One of those risks is a wave of selling by U.S. investors, who are major shareholders in many energy trusts and will be hit with an increase in the amount of tax that will be levied on their distributions.

Ms. Mo thinks U.S. selling of energy trusts could pick up later in the year as investors begin tax-loss selling. The positive spin here: If energy trust prices fall another 10 per cent, then they start to become a compelling value.

Business and infrastructure trusts are what primarily interest Ms. Mo right now. She's looking for the ones with solid underlying value as well as sustainable cash flow and other hallmarks of successful businesses.

Ms. Mo said there are currently about 257 income trusts listed on the Toronto Stock Exchange, 125 of which she won't touch. "There's so much junk in this space," she said of the trust market as a whole.

By the time the new trust tax takes effect in 2011, Ms. Mo sees about 50 fewer trusts than there are now as a result of acquisitions and privatizations. Those that remain will convert into corporations that trade as dividend stocks, some of which will be well-followed names, while others turn into orphan stocks.

Ms. Mo plans to adjust to future changes in the trust market by including more dividend stocks in her portfolio. Dividend stocks don't typically offer anywhere near the same yields as income trusts do, but she thinks the gap will narrow as a growing number of corporations decide to increase the amount of dividends they pay.

"More and more companies are realizing that what investors want is a higher yield," she said.

Looking ahead, Ms. Mo sees a convergence between trusts and dividend stocks in which yields top out around 5 to 6 per cent for the most part. This will be disappointing news to people who were accustomed to getting 8 to 10 per cent or more from trusts, but it's still a lot better than the 4-per-cent yields available from long-term government bonds.

Investors who are tempted to chuck trusts altogether should know that the pros who run mutual and pension funds are in buy mode right now because of the trust market's pullback this month. In fact, Ms. Mo said colleagues of hers who avoided trusts in the past are now expressing interest.

The trust market as we know it is winding down, but there are still opportunities. To find them, you have to stop dwelling on what happened two weeks ago and start looking ahead.

Flight plans

Readers have been asking when the second half of a two-part look at alternatives to the Aeroplan customer loyalty program will appear. Barring a major news development, it will be Tuesday.

© 2007 The Globe and Mail. All rights reserved.

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