Earning Your Trust

These trusts are essentially investment syndicates that pool their funds to buy cash flow-generating assets, with that cash flow (after expenses) distributed directly to the unit holders.

Such an income trust is simply a way of organizing a business, a corporate structure that Canadian businesses can choose to avoid paying taxes. Essentially, they create a trust subsidiary and flow all of the profits into it, where they can't be taxed because the bulk of the revenue stream is paid to shareholders, after the trust retains a mandatory 15% as an operational safety margin.

To better translate the technical jargon above for the uninitiated, I'll describe these holdings the way I do when introducing this asset class to clients: by using Prudhoe Bay Royalty Trust (BPT - commentary - Cramer's Take) as an example. Prudhoe Bay is the famed oil field on the North Slope of Alaska.

The trust itself is not an operating company, merely a corporate entity that owns a royalty interest on the first 90,000 barrels of oil produced daily at this field. Similar to a REIT, the trust collects its income and pays out essentially all of it to shareholders, making it a high-yielding vehicle (current yield: 11.7%). And although I'll talk more about taxes in the third column in this series, that yield is even more attractive because part of it is tax-free; because the oil field is a wasting asset, part of the distribution each year is considered a return of principal and therefore is not taxed.

I use this U.S.-based example because its name is familiar, it's one of a small handful that trades on our market, it's priced in U.S. dollars and it provides for a simple explanation. However, the greatest wealth of opportunity in this sector lies north of the border in resource-rich Canada, where more than 200 such royalty trusts trade, the majority of which are related to the energy industry.

Because there is such a huge list of names, investors will have to do some homework on their own or find an adviser who's well-versed on the subject, but information on those Canadian issues is available in abundance online for anyone willing to dig just a bit. The best source I know: Canadian Edge, a newsletter I recently described in more detail.

Value Remains

Staying with Prudhoe Bay for a moment, a look at its long-term chart would initially give most investors pause:

That's Some Move Prudhoe Bay has seen impressive gains since 2003

Source: StockCharts.com