Top two risks of income trusts
1. There's no guarantee you'll make money when you sell your units.
Like stocks and shares, the value of income trust units can go up and down. For example, the changes in the tax rules announced in October 2006 caused the price of income trusts to drop quickly.
2. There's no guarantee that you'll get distributions.
Many people buy income trusts believing they will get regular, stable cash payments. But distributions are not guaranteed. This is one of the greatest risks in buying income trusts.
Under the new tax rules, income trusts will likely have less money to pay out to investors. Investors can expect smaller distributions in the future. What you get will depend on how well the business or the investments behind it perform.
Each income trust will have its own individual risk profile. Some of the factors include:
- Local and general economic conditions - including changing interest rates
- Government regulations and environmental matters
- Business risks that are specific to the industry involved
- Production and operating risks that are specific to the company
- Skill and know-how of the management team
- Accurate estimates of what the company expects to make in the future
- The price of the underlying commodity for an energy trust - such as oil or gas - and how long the reserves last.
In addition, you should be aware that tax rules for income trusts may continue changing from time to time. This can affect the amount of distributions you get and the price of the units.
How can I tell if an income trust will likely pay distributions?
Look closely at the distributable cash. This is the amount of cash that the trust has available to pay investors. The challenge is that there are currently no accounting standards or rules about how companies determine the amount of their distributable cash. Trusts can even borrow the funds to pay distributions.
This makes it hard for investors to compare income trusts on the basis of their distributable cash. It can also be difficult to assess whether an income trust will be able to sustain its distributable cash and deliver solid, long-term returns in the future.
Remember: The risk with income trusts varies
Some people think they are like bonds and have less risk than an investment in stocks. But unlike many bonds, distributions are not guaranteed. And, you can lose money if the income trust units drop in value. Make sure you understand the risks before you buy.
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.