In Trusts Should We Trust?

Yesterday we offered investors a brief primer on the many ways that investors can wring income from equity investments. Such options include common stock, preferred stock, REITs, and investments in limited partnerships.

But there was one option we didn't include, as pointed out to me by a reader. We didn't discuss trusts -- specifically, royalty trusts. Given the sometimes eye-popping yields offered by trusts, and the fact that most trusts pay out on a monthly basis, it's an omission we'd do well to correct.

For starters, fellow Fool Bill Mann offered investors a review of trusts a couple years back, and I encourage investors to read that, as well as other trust-related articles he's penned over the years. In Bill we trust.

But for those who don't want to look backwards before looking forwards, here is a brief overview.

Trusts are set up to funnel the royalties from a collection of assets to the owners of the shares of the trust. Whether the trust owns stocks, bonds, oil/gas properties, timber, or real estate (remember REIT stands for real estate investment trust), it is a way for shareholders to reap income from a collection of assets.

American trusts are often wasting assets -- created to pay dividends from a certain pool of assets without necessarily replenishing those assets. This is particularly true in the case of American energy trusts -- while they can make capital expenditures, they usually don't (beyond what is necessary to maintain the royalty assets). Nor do they tend to take on additional debt or equity financing.

Consequently, an American energy trust is basically an ATM -- it'll continue to dispense cash (based upon the price of the oil/gas sold from those properties) until it's empty, but nobody is going to come by to reload the machine.

By comparison, Canadian trusts are often actively managed, will use debt and hedging, and are frequent and active acquirers. Thus, in many ways, Canadian trusts behave more like many limited partnerships than American-style trusts.

Of course, there are some catches. Most Canadian trusts aren't listed on American exchanges, their value is somewhat tied to exchange rates, and the Canadian government has placed limitations on non-Canadian ownership. What's more, Canada tacks on additional taxation, such as a 15% foreign withholding. As a result, those Canadian trusts that do trade in the U.S. often offer a higher yield.

As in the case of limited partnerships, the personal tax consequences of trust investments are complex. Since the initials after my name are "CFA" and not "CPA," I'll squirm out of a long tax discussion by simply pointing out that there are tax advantages to owning trusts but that investors need to seek out professional tax advice on their individual tax ramifications.

Investors looking for some stock-specific ideas should check out some or all of the following (these are by no means recommendations, but rather suggested starting points):

American energy trusts:

  • San JuanBasin (NYSE: SJT  )
  • Cross Timbers (NYSE: CRT  )
  • PermianBasin (NYSE: PBT  )

Canadian energy trusts:

  • Enerplus (NYSE: ERF  )
  • PengrowthEnergy (NYSE: PGH  )
  • PrimeWest (NYSE: PWI  )

Though not traded on a U.S. exchange, I'd also suggest that investors willing or able to buy shares on the Toronto market take a look at Canadian Oil Sands, as well.

Lastly, I'll also offer up an interesting non-energy trust -- Texas Pacific Land Trust (NYSE: TPL  ) , a company with an unprecedented commitment to ongoing buybacks.

Because of their ties to the price of the underlying assets, trusts can be volatile and they are not suitable for all investors. But for those investors looking for a different angle on energy and/or income investment, they are at least worth a little bit of research.

For more trustworthy takes on trusts and income investment ideas, check out:

Want to see how Mathew Emmert is using income-generating investments to beat the market? Take a peek at his Motley Fool Income Investornewsletter, free for 30 days.

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).

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