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What are income trusts?

Income trusts are similar to mutual funds in some respects. The investments are professionally managed and sold as units to investors, who then receive income from the company’s operations. Unlike mutual funds units, income trusts are sold on the stock market.

There are a vast variety of royalty and income trusts to choose from and they can range everywhere from oil and gas companies, to fast-food restaurants, to real estate investments referred to as Real Estate Investment Trusts (REITs). Income trusts have recently gained media attention with respect to the privatization of Hydro One. As an income trust, the government would continue to own Hydro One but it would sell units of the electricity transmission and distribution company to investors. Investors would in turn receive a portion of the company’s cash flow. Some, however, have questioned turning Hydro One into an income trust. There is the issue of debt, and how little income would be left over for distribution. Buyers would be almost exclusively retail investors, since institutions are not that interested in trusts. Another factor is capital requirements. To obtain higher returns from a trust, the trust must have minimal capital requirements, whereas Hydro One’s future capital requirements are substantial. In general, income trusts are marketed for a limited period of time, at which time the trust is closed to new purchases. When the time has transpired, often a new pool of investments is set up with similar holdings, and again offered on the market. The majority of income trust investments have a holding period of five years. After the lifetime of the income trust, many investors redeem the investment and purchase another income trust when it offers tax advantages. If you redeem your units early, and you may incur capital gains taxes. Safeguards to investing When buying income trusts, the quality and the long-term stability of the company are critical. Thorough research and financial expertise is recommended before purchasing an income trust. Some wrongly believe that income trusts are as secure as guaranteed investment certificates, but if prices for the commodity on which the trust is based plunge, so do the returns on the trust. Many income trusts are sold as conservative investments, but in actual fact they are very risky. There are also tax implications involved when purchasing income trusts and it would be wise to speak to a professional accountant before making an investment.