There are some interesting parallels between today's income trust market and technology stocks circa 2000 at Tony De Thomasis's financial advisory firm in Thornhill, Ont.
Clients are clamouring to invest in income trusts just like they did with tech stocks four years ago, said Mr. De Thomasis, who has 25 years of experience as an adviser. "They think trusts are going to keep going up," he said. "I thought that after what happened in the tech sector, people would be a bit smarter. But they still think that if they made money in trusts last year, it's a good reason to buy again this year."
Mr. De Thomasis likes trusts just fine, in principle. He thinks they're a good way to generate income in a portfolio and he began selling them to clients back in 2000 through income-trust mutual funds. Today, though, he's concerned that trusts are overvalued and that clients have too much exposure. In fact, he's so concerned that he is declining when clients ask him for more exposure to trusts.
"It's hard as an adviser," said Mr. De Thomasis. "It's hard to say no to a client."
Mr. De Thomasis contacted the Personal Finance column by e-mail recently after reading comments that trusts are overvalued and unattractive right now, despite the fact that they have received a final stamp of legitimacy through inclusion in the S&P/TSX composite index.
His point was that investor enthusiasm for trusts reminds him of tech mania. Now, don't dismiss him as an alarmist. To be precise, Mr. De Thomasis doesn't think trusts are a sector-wide bubble like tech stocks were. His worry is that investors are overloaded with trusts to a point where they may have a trust mini-bubble in their portfolio. If trusts fall in value, these investors could be in for a shock.
This is why Mr. De Thomasis has been suggesting to clients that they sell off some of their trust holdings to bring them in line with what they were when they first got into the sector. If the trusts in a client's portfolio grew to 40 per cent of the total from their original target of 20 per cent, then he would suggest they sell down to that level.
Clients, not surprisingly, are resisting, Mr. De Thomasis reports. "It's the same thing I heard when clients had tech stocks in 2000. They say, 'well, I think if I keep them I'll make money because from what I hear the market is going to keep going up for a few years.' "
Maybe that will happen, but probably not. When you consider that the average mutual fund in the Canadian income trust category made a compound average annual 17.5 per cent over the past five years, it's hard not to foresee a correction that brings these numbers closer to what one normally expects from equities, which is what income trusts are at the heart of things.
The one argument you can make in favour of trusts right now is that low interest rates, decent economic conditions and high commodity prices are helping the vast majority make their monthly or quarterly distributions. So if you buy trusts for income, you're getting what you paid for.
The problem here is that in Mr. De Thomasis's experience, most people with income-trust mutual funds are reinvesting their distributions and not taking them out in cash.
In doing so, they're buying back into the trust market at today's tip-top prices, and they're also putting pressure on their fund managers to put this reinvested money to work at a time when bargains are few.
What's interesting about Mr. De Thomasis's trust-happy clients is that some of them lost money when tech stocks collapsed. "A lot of people who got burned think income trusts are more secure. They say, I got burned on the equity side, so I'm going to buy more on the income trust side."
These investors may not remember the pain of 2000-2002, but Mr. De Thomasis does. Back then, he reluctantly agreed to accommodate clients who demanded to invest in technology.
Instead of buying tech funds, though, he bought growth-oriented equity funds that had tech stocks as part of their mix.
"My thinking was that if the markets ever did turn around, the managers would be able to move the money around. It didn't work, though. Because the tech sector dropped so fast, they couldn't get out fast enough."
This experience has persuaded him to resist when clients want to load up on trusts today.
"I have told my clients that I will not do it, and if they want to fire me -- so be it," he wrote in his e-mail. "If I did this in 2000 I may have lost a few clients, but the majority of my clients would have been very, very happy."