Growing Hunger For Business Trusts

Foreword from ShareInvestor

This article “Growing Hunger For Business Trust” by Jonathan Kwok was first published in The Straits Times on 17 Jun 2012 and is reproduced in this blog in its entirety.

More of these versatile vehicles are listing here, providing a high-yield investment option

They were largely an unknown here a few years ago but business trusts are gaining in popularity both among firms looking to list and investors looking for another way to make a dollar.

As in any investment that treads new ground, there is no end to confusion about how it all works and the risks and returns.

Investors have plenty of incentive to do their homework on business trusts given the opportunities coming their way.

The upcoming initial public offering (IPO) of Malaysian gaming business Sports Toto Malaysia is a hotly anticipated one as is Indian hospital trust Religare Health Trust.

These entities are being listed just a year after last year’s US$5.5 billion (S$7 billion) mega listing of Hutchison Port Holdings Trust, a trust holding port assets in southern China and Hong Kong.

If investors think they want a piece of the action in these listings, it is essential that they know the mechanics of a business trust before opening their wallets.

What Is A Business Trust?

A trust is a versatile vehicle that can invest in a wide range of sectors and assets as long as they can produce income, such as through long-term lease agreements to third parties.

Buildings, ships, ports, power plants and desalination plants are among assets that have been injected into Singapore-listed business trusts.

Singapore created the framework for listing trusts much earlier than Hong Kong or Malaysia, which explains why many trusts holding regional assets have come to list here.

There are nine business trusts listed on the Singapore Exchange, providing another option for income investment, alongside real estate investment trusts (Reits) and dividend-rich company stocks.

Business trusts typically appeal to longer- term investors seeking regular income streams.

These yield vehicles pay out dividends from the underlying asset’s cash flow.

Singapore-listed trusts are paying a yield of between 3 per cent and 10 per cent.

There are two outliers: First Ship Lease Trust has a historical yield of more than 15 per cent because over the past year, it made a one-off distribution to existing unitholders that is unlikely to be repeated.

The other is Indiabulls Properties Investment Trust, which has not declared distributions.

With bank deposit rates mostly below 0.5 per cent and inflation at over 5 per cent, the allure of business trusts increases. After all, they offer stable and regular payouts, and annual yields that can exceed 8 per cent.

“The yield was the main factor,” said 27-year-old civil servant Chong Chun Siang, who invested in First Ship Least (FSL) Trust in the middle of 2010.

“The yield back then for FSL Trust was around 11 per cent. It was a big draw factor.”

Differences With Other Vehicles

Business trusts are a much more flexible structure than Reits.

Reits can contain only real estate assets while business trusts can hold all kinds of assets, including real estate.

Unlike business trusts, Reits also face restrictions on the level of debt gearing they can undertake.

And no more than 10 per cent of the properties in a Reit can be under development at any one time.

Such a restriction does not exist for business trusts.

Mr Tan Kok Huan, managing director of asset-backed structured products at DBS Bank, said that Ascendas India Trust and Perennial China Retail Trust are two examples of business trusts that had more than 10 per cent of their properties under development at IPO – which they would not have been able to do if they were Reits.

Reits can enjoy some tax benefits if they pay out at least 90 per cent of income as distributions.

These benefits are not open to business trusts so there is theoretically no restriction on how much they must distribute, although most trusts pay out most of their income.

When compared with companies, business trusts can declare distributions straight out of cash flow while businesses must pay dividends from net profits.

“For businesses with high initial capital expenditure – such as real estate or shipping, it may make more sense to set up a business trust so that there is greater flexibility with regard to the distributions,” said Dr Victor Yeo, associate professor at Nanyang Technological University’s business school.

This is because the non-cash items of the depreciation and amortisation of capital can be a large drag on accounting profits.

By paying out of cash flow, business trusts can make distributions higher than the net profit, which they cannot do if they are structured as companies.

What all this means is that investors in a business trust can potentially receive higher yields than if they put money into shares of a company with similar operations as the trust.

Ms Ang Suat Ching, head of corporate finance of OCBC Bank, said: “For investors, business trusts are yield-attractive investment options that pay dividends from their operating cash flows.”

Attractions Of Business Trusts

The topline yield figures are an obvious draw.

Mrs Eng-Kwok Seat Moey, managing director and head of asset- backed structured products at DBS Bank, said that business trusts provide a transparent vehicle for investors seeking yields.

The investment mandate for the trust – be it in infrastructure or shipping, and the geographic mandate – will be very clear.

And the trustee-managers will also typically stipulate clearly the dividend policies of the vehicles, although they are not legally bound to do so. “They’ll want to give clarity as they are selling it as a yield product,” said Mrs Eng-Kwok. “You’ll know exactly what you are buying into.”

One advantage that business trusts have over Reits is that they have no limitation on how much asset under development it can hold.

This means unitholders can potentially benefit from capital gains of the properties under development, which are likely to be stronger than for properties already built up.

But property development also comes with some risks that unitholders need to be mindful of.

Risks And Things To Consider

There are the usual business risks that will be encountered regardless of whether an investor buys company shares, Reit units or into a business trust. Investors need to note that although business trusts are marketed as stable yield vehicles, some can be highly exposed to business cycles as well.

This depends on the nature of the underlying asset. In troubled times, the distributions may have to be cut.

Take shipping trusts, which hold vessels leased out to operators. They have seen unit prices drop amid the shipping slump, and distributions have fallen in some cases.

There is also a currency risk investors need to be aware of. If distributions are declared in a foreign currency, the amount received in terms of Singdollars will depend on exchange rate movements.

Some observers have attributed this factor to the underperformance of Hutchison Port Holdings Trust, whose units have dropped below the IPO price.

This trust declares distributions in Hong Kong dollars, which is pegged to the US dollar, introducing foreign exchange risk to a Singapore investor.

The sponsor and trustee-manager are vital to the health of the trust. The investor needs to decide if the sponsor is willing and able to financially support the trust if it runs into problems, such as with financing during a crisis.

A trustee-manager’s track record of acquisitions and management is important, and investors should study if it has previously bought quality assets at good prices.

As there are no restrictions on business trusts’ borrowings, they may be more highly geared than Reits and thus more vulnerable to funding strains.

Investors should check the debt level and decide if they are comfortable with it.

Performance Of Trusts Here

Business trusts in Singapore have generally fallen below their listing price, leading some investors to suffer losses on their investment capital. That has led observers to advise caution to new investors here.

For instance, Mr Chong reckons he lost about 45 per cent on FSL Trust after a cut in distributions led him to sell his stake.

This has put him off investing in shipping trusts though it has not dampened his appetite towards business trusts in general.

Mr Tan from DBS stressed that the business trust is “just one of the legal structures to list a business”.

“Regardless of whether it is a Reit, a business trust, or a company, how it performs depends on the underlying business.

“You should look at the underlying business and compare it with a company in the same industry.”

For instance, shipping trusts like FSL Trust and Rickmers Maritime should be compared with similar ship-owning companies rather than other business trusts in different asset classes.