Common in Canada. Also known as royalty ("canroy") or resource trusts.
Formed by groups of investors who pool their resources to purchase a cash-generating asset. For example, REITs (real estate investmnet trusts). There are also oil and gas trusts.
Bought and sold like stocks, they are not stocks. They are special-purpose vehicles designed to receive and distribute income from underlying assets. Owning units in a trust does not mean fractional ownership of a company the way stocks do.
Most income trusts have tax advantages (unlike common stocks which don't) and they trade on exchanges as "closed-end funds" with a fixed number of units (shares) available.
Advantages:
- Steady source of income, typically paying quarterly distributions.
- Tax advantages.
- They enable investors to invest in things that would otherwise be too illiquid or inaccessible for the average investor. Though most of us can't take a personal stake in an oil patch, we can do so indirectly through an energy trust.
Risks:
- If oil and gas production becomes stagnant, the value of the assets declines and available cashflow for distribution shrinks. Investors can suffer both falling unit price (principle), and shrinking distribution (yield).
Criteria for selection:
- Sustainability: a trust's payouts may be self-destructive (like a Ponzi scheme). Choose only trusts with sustainable payouts.
- Choose only trusts whose underlying assets are likely to continue to appreciate. Don't buy near the top!
- Experienced and cpable management.
- High internal ownership (management eats its own cooking)
- A proven and sustainable business model.
- Technological and operational advantages.
- Steady history of dividends.
- Cost-effective plan for replenishing reserves.
- Low operating costs.
- A history of consistent growth.
- Strong potential for continued growth.
More about the tax advantages:
Income from Canadian trusts is tax-free to Canadians as long as they maintain their mutual fund status. (Some legislation proposes to force them to become corporations thereby diminishing their appeal.) U.S. investors in Canadian trusts enjoy these tax benefits, too, but must pay a 15% nonresident withholding tax to the Canadian government (of which a percentage can be refunded.) Some trusts are treated by U.S. law as "qualified foreign corporations."