Business Trusts To Give Good Yields

Foreword from ShareInvestor

This article “Business Trusts To Give Good Yields” by Jason Low was first published in The Business Times on 10 Dec 2007 and is reproduced in this blog in its entirety.

Jason Low looks at this relatively new asset class which has been largely neglected and not well understood by the local market

As the entire market eagerly awaits the impending Fed announcement on interest rates, many are still second guessing the exact amount of sub-prime writedowns suffered by the major financial institutions worldwide. In recent weeks, the market has been extremely volatile mainly due to ongoing concern over the global credit crunch.

In such times of uncertainty, what types of investments should investors turn to? A relatively new asset class of investments in the local market, collectively named as “business trusts” might be something worth a look.

Understanding The Structure Of A Business Trust

Business trusts are basically business enterprises set up as trusts, instead of companies. Assets are first acquired or injected by a sponsor and put under the management of a trustee manager. The funds to acquire assets for the trust can be raised through IPOs from investors like you and me. Once one purchases a business trust unit, he becomes a unitholder and he beneficially and economically owns the assets and income of the trust.

As a unitholder of the business trust, one receives a regular income flow generated by the operation of the underlying assets. This is why a business trust structure is more suited for businesses with stable growth, cash flow and steady income-generating assets such as utilities and vehicle leases.

Essentially, unitholders provide financing to the trust. In turn, the trust uses these funds to invest in assets which will then provide a return. For example, in shipping trusts, the principal income-generating activity is the lease payments received when the trust leases out its ships to lessee companies for a certain defined period at a fixed rate, thus securing the income flow for that particular period.

The concept of a listed business trust is relatively new here, though similar structures have been present in other markets for many years and have been doing exceptionally well. One type would be the Master Limited Partnerships (MLPs) listed in the US which employ the same structure as that of business trusts.

The first business trust in Singapore, CitySpring Infrastructure Trust, was listed on Feb 12 this year. Since then, there have been another five new business trust listings on the Singapore Exchange, with the bulk of them coming from shipping and infrastructure businesses where income flow is stable and regular.

Take CitySpring Infrastructure Trust, for example. Its core businesses are the production and sale of town gas through its wholly-owned entity City Gas and water desalination through SingSpring. Such infrastructure and utility businesses are very stable thanks to the constant day-to-day demand for energy and water usage in Singapore. Thus the trust is able to generate regular income streams from these core businesses.

In fact, “providing unitholders with long-term, regular and predictable distributions and the potential for long-term capital growth” has been the principal objective of CitySpring as stated on its SGX corporate profile.

How Can Investors Leverage On Business Trusts?

In times of uncertainties, business trusts offer a safe harbour due to its potential yield play and stability. The trusts generally have higher yields compared to general equities. Locally-listed business trusts yield an average of 8 per cent, with the shipping trusts giving a relatively higher yield of 9-11 per cent. This is significantly higher than the average dividend yield of the STI component stocks.

Such high income yield serves as a cushion should the trust suffer a significant loss in its stock price. However, business trusts have historically been more stable and less volatile than general equities. This is due to the nature of the underlying core businesses which are mainly in industries where income flow is regular and stable such as utilities and shipping.

Further, business trusts have a more flexible payout policy than companies. While companies are restricted to paying dividends out of accounting profits, business trusts make distributions out of operating cash flows. This enables it to maintain its yield policy.

However, one must understand that a business trust will have relatively lower growth prospects compared to general equities. While business trusts are relatively less risky due to their low beta and high dividend yields, the tradeoff is that growth may be lower. This is mainly because a trust is in essence a pool of income-generating assets with a generally fixed income flow. This is unlike a normal listed company where income variability and potential growth might be higher.

That said, there are listed business trusts with growth plans as well. For example, the management of the three locally-listed shipping business trusts in Singapore have been expanding and diversifying their fleets to bring about more growth for unitholders.

Locally-listed business trusts still lag their US counterparts in terms of pricing and yield compression. This can be explained by investors’ lack of familiarity and understanding of this relatively new asset class.

Indeed, in the uncertain times ahead, a fresh understanding of business trusts might pay dividend in the long run.

In times of uncertainties, business trusts offer a safe harbour due to its potential yield play and stability. The trusts generally have higher yields compared to general equities.