In income we trust? An empirical examination of the Canadian Income Trust market
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The recent phenomenal growth in the Canadian Income Trust (fund) market, from $17 billion in 1998 to $70 billion in 2004, was triggered by investors' demand for double-digit yields in an era of low interest rates and equity returns. However, similar to many other comparable asset classes, income trusts are not free of risk. The current favorable tax environment for income trusts is always subject to change while unitholders' unlimited liability is still an unresolved issue. Furthermore, some market observers are arguing that the trust market might be nearing to a speculative bubble stage. Trusts are also not all equal in both their nature and size of operations and understanding the trusts' underlying business should be an astute investor's first step long before investing in an income fund. In the first part of this thesis we fill in the need for empirical research on the Canadian Income Trust market by examining the risk and return characteristics of various types of income trusts using a battery of financial ratios over the sample period 1998-2003. The results obtained show that utility trusts have the lowest return and risk than the other types of trusts while the oil and gas trusts exhibit the highest return and risk. Moreover, we also compare financial ratios of Standard and Poor's (S&P) rated income trusts to unrated ones. The results lend some support to the premise by the S&P in that ratings serve the investment community by signaling the potential for stable and higher dividend yields. Subsequently, a comparison of the Canadian Income Trust market to alternative investment assets revealed that with roughly 20% return, the Canadian Income Trust market significantly outperforms other equity and fixed-income securities markets over our sample period of 1998 to 2003. Despite this large disparity in returns, the income trust sector has approximately the same level of risk as the other asset classes. Also low or negative correlations between the trust market returns and other asset classes suggest that by allocating a portion of an investment portfolio to income trusts investors can enhance their portfolios' long-term return potential through diversification. The second part of this study analyses the wealth effect of the announcement of several trust-related events by calculating the abnormal returns experienced by unitholders on the announcement dates. These events relate mainly to the taxation of income trust, launch of the S&P/TSX indices, and S&P public stability ratings. The outcomes show that announcements, which contribute towards both the recognition of the unprecedented growth in the income trust market and unitholders' need for information about the income trust market, produced significant cumulative abnormal returns on the event dates.