John Priestman didn't wait for federal tax changes to fully transform the Canadian income-trust universe before making changes to the BMO Guardian funds that he co-manages.
Priestman, whose income-trust-heavy funds include the $446-millionBMO Guardian Monthly High Income Mutual, notes that by this spring many income trusts had already converted to corporations.
Consequently, he and his colleagues at Guardian Capital LP believed it was an opportune time to add dividend-paying common stocks to BMO Guardian Monthly High Income and a very similar fund, the $601-millionBMO Guardian Monthly High Income II.The Guardian Capital team's picks include Rogers Communications Inc. ( RCI.A), Shaw Communications Inc. ( SJR.B) and Imperial Oil Ltd. ( IMO).
The thinking behind adding companies such as these, according to Priestman, was that by 2011 all trusts will have been converted to common stocks. "So why not take advantage of very depressed, high-quality common stocks right now, rather than waiting, when they'll be 30% to 40% higher?"
The Guardian Capital equity-income team, whose other portfolio managers are Kevin Hall and Michele Robitaille, believes that business fundamentals and future dividend policies are the important drivers of future performance. Accordingly, Priestman downplays the structural advantages that income trusts have lost as a result of tax changes first announced on Oct. 31, 2006, by federal Finance Minister Jim Flaherty.
"The high-quality trusts have come through pretty much with very stable operations, no disappointments," adds Priestman. As well, there have been a number of trusts that have announced that when they become corporations, they will maintain their current distributions. "So you can cherry-pick these kinds of companies, overweight them, and it's going to be a huge, positive event for unitholders."
Priestman notes that when income trusts convert to corporations they will pay corporate dividends, instead of the income distributions that they previously paid as trusts. Unlike dividends, which enjoy favourable tax treatment, income trust distributions are normally taxed as ordinary interest income. In most provinces, dividends are about 40% more tax efficient than interest income, adds Priestman. "So you're really no worse off on an after-tax basis (with a conversion to a corporation)," he concludes.
Further mitigating the impact of the federal tax changes was the broad exemption given to Canadian real estate investment trusts (REITs). They remain a mainstay of BMO Guardian's funds in the Canadian Income Trust Equity category, with a weighting of about 30%.
Another reason cited by Priestman for looking on the bright side is that energy trusts aren't going to be affected for "probably three or four years." When energy trusts do begin paying taxes on their distributions, he adds, it's going to be at a low rate of somewhere between 10% and 15%.
Priestman's sell discipline is based on the philosophy of preserving profits and limiting losses. Typically, the portfolio consists of 25 to 35 holdings. Despite the managers' due diligence, Priestman says two to four of their holdings at any one time generally won't perform as well as expected.
On the bright side, he adds, two or three names will perform surprisingly well. "So the key for me is to take those three or four underachievers and recycle them back into much better names to get very good, consistent returns."
Priestman, who draws on three decades of investment experience, graduated with a bachelor of arts in economics from the University of British Columbia in 1968. He moved to Toronto in 1969 to join investment boutique Bell Gouinlock as a bond trader.
In 1972, he moved to Royal Trust as a senior investment manager. In 1978, he became a money manager with Hospitals of Ontario Pension Plan. Then in 1985, he moved to Guardian Capital, where he is now managing director.
Under Priestman's tenure since its inception in October 1996, BMO Guardian Monthly High Income Mutual has an annualized return over the past 10 years to Oct. 31 of 11.6%. That's in line with the median return among the handful of Canadian Income Trust Equity funds with 10 years of performance history.
Whether he retires or stays on over the next decade, the 63-year-old Priestman says investors will be in good hands. "I'm one of those type A personalities, I'll probably die with my boots on," he says. "But the reality of the situation is, Kevin (Hall) and Michelle (Robitaille) are both in their high 30s, they've both been in the business for 16 years, they're really good, so I think we're in really good shape. Plus we've got Ted Macklin, who's a specialist in large-cap Canadian equity as part of the team. So when I fade off into the sunset, we're well fixed up in terms of continuity."
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