Income trust standards (or lack thereof) and risk

So everyone and their grandpa is still upset about the recent change to income trusts introduced by the Canadian federal government. The change was, of course, to implement a tax on trust income similar to corporate income tax.

The outrage epicentre is Bay Street, Canada’s version of Wall Street, in the heart of the financial district in downtown Toronto. But in the radiating waves of anger from that focal point, senior citizens seem to be most upset. Could that be because they are more likely to be Conservative party supporters, the party that pledged no trust tax in the last election? Possibly, but it also has to do with retirement savings and poor investment advice.

The most apoplectic are the ones who concentrated their investments in the risky vehicles.

This violates the sacred first rule of investing – diversify your holdings. Unfortunately, it seems that the only diversification many people paid attention to was in the underlying nature of the trust business – i.e. natural resources (oil and gas trusts are huge). It didn’t occur to anyone to diversify amongst vehicles – some trusts, some equities, some bonds, some derivatives, etc.

The risky nature of trusts is related to the relative lack of policing by either securities regulators, or accounting standards setters. Distributable cash is a key metric for trusts, because they are by design supposed to distribute nearly all cash generated, and one that has to this point been ignored by both parties above.

The accounting standards body in Canada, the AcSB, has no guidance on trust disclosure, and the national securities regulator, the CSA, has only suggestions as to disclosing that distributable cash is estimated based on reasonable assumptions. As Al Rosen, a popular Canadian accountant and frequent contributor to various business publications, points out: “Is any company about to admit that their predictions of distributable cash are completely unrealistic?”

Trusts need more attention from accounting standards setters and securities regulators, that much is certain. But investors also need to be aware that diversification should be done across investment vehicles, as well as industries. Both carry different types of risks.