In income we trust? An empirical examination of the Canadian Income Trust market
Date
2004-08
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Masters
Abstract
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.
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Degree
Master of Science (M.Sc.)
Department
Finance and Management Science
Program
Finance and Management Science