(March 25, 2004) In a budget virtually bereft of surprises, the restrictions placed on pension fund investment in income trusts stands out for the investment community. While retail investors piled into trusts as a refuge from the bear market, pension funds patiently sat on the sidelines, awaiting legal clarification on the liability issue.

Legislation was drafted in Ontario, tabled and passed to its final reading… before dying on the order paper when then-premier Ernie Eves called an election. Then the new government promised to reintroduce the bill. The stage was set for pension funds to move in.

Then came the 2004 federal budget.

But are the pension fund restrictions really negative for the trust sector?

“It doesn’t appear to me that it’s going to affect us at all,” says Leslie Lundquist, manager of the Bissett Income Trust and Dividend Fund. “It didn’t appear to take aim at the small investor, the individual nor did it try to stop institutions outside of pensions. Mutual funds such as ours remain free to invest in whatever we see fit.”

Many investors had been looking forward to the upside price pressures the pensions would bring to the trust sector. Those hopes are now put on hold leaving trusts to their original purpose: providing income.

“It sure could have been worse,” says Lundquist. “We care about the income. The operating environment hasn’t changed, so from our point of view it hasn’t made a difference.”

Lundquist says entry of pensions could also have reduced the liquidity of the sector as the funds bought and held the more attractive issues. In fact, the absence of such price inflation could be a positive for funds looking to shore up their holdings in trusts.

“In terms of price, this could be viewed very positively for individuals, because they can buy trusts at higher yields than they would have if the pensions had come in and pushed up the price.”

Lundquist speculates that the restrictions could leave even the pension-eligible trusts — real estate investment trusts (REITs) and resource royalty based — off the TSX index. Because the index is used as a benchmark for pension fund performance, indexers might be reluctant to include pension-ineligible holdings in the index.

“The potential negative for the oils and the REITs is that the S&P TSX Index committee may decide that, if pensions can’t invest in some income trusts, they’re just not going to put trusts into the index at all,” says Lundquist, cautioning this is simply speculation.

But there may yet be hope for pension funds seeking broader exposure to trusts, since the decision could someday be reversed.

“Pension managers are crying foul,” says Don Ogden, a chartered financial analyst at Raymond James in Vancouver, pointing out business trusts have a market cap of about $45 billion. “The business trust sector has been an expanding area of the market. That represents a big opportunity cost to pension managers, so expect the lobbying of the pension industry to intensify.”

That lobbying effort appears to be underway already, as the Ontario Teachers’ Pension Plan (Teachers’), one of the biggest trust market players — pension or otherwise — issued a press release on Thursday explaining their opposition to the proposed cap.

Unlike most pension funds, Teachers’ did not wait for the liability issue to be settled and moved aggressively into the income trust market. The fund will likely have to sell off some of its trust holdings to stay onside with the limit of 1% of book value.

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  • “Over the past two years, the Teachers’ fund has acquired significant income trust investments worth over $1 billion today,” the press release read. “These holdings are already beyond the 1% limit suggested by the federal government in its budget earlier this week.”

    “The proposed cap on income trusts seriously discriminates against the 250,000 teachers and the millions of Canadian workers whose retirement income is managed by pension plans,” Teachers’ president and CEO Claude Lamoureux said in the release. “This proposal would unfairly exclude them from benefiting from the growth and stable cash flows income trusts are expected to provide.”

    The plan says the limit is unfair as it will put it and other pension funds at a disadvantage to other institutional investors which are not subject to the restrictions.

    “The proposed caps are unnecessary. The federal government receives tax revenue from teachers’ pension income,” says Lamoureux. “Our retirees received $3.2 billion in pensions in 2003 and paid $800 million in tax to governments.”

    Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

    (03/25/04)