One of the pat lines that one Contra Guy clings to when speaking publicly is: "Dividends allow me to be stupid longer." This phrase has always been part of the Contra idiom and continues to hold true. If you buy a stock and the price goes down for years, but a dividend cheque arrives in the mail, at least there is some financial return -- with the dividend tax credit to boot.
A few years ago, dividends were considered to be the offal of investing, as the focus was technology and rapid stock price appreciation. Since the blow-off in that never-never land, investment trusts have become a highlight, and it seems like everyone and his uncle are bringing one to market. While many are worthwhile, others are overpriced from the outset and their business models are murky. Simply because something is labelled a "trust" by no means makes it trustworthy.
One that we bought outside the Contra portfolio was Algonquin Power Income Fund (APF.UN-TSX), as both of us were looking for a diversification platform to balance the nature of other investments. Algonquin was desirable, because as an owner of numerous hydroelectric generating facilities, it was a play on a renewable resource, as compared with non-renewable alternatives such as oil and gas. Depletion of assets in many investment trusts is a concern.
However, while the two of us were in accord on all the reasons to purchase the firm, our current attitudes toward it are different. One of us decided to sell all of his holdings, while the other sold half. Hey, it happens in every partnership.
The one who sold his complete position became disenchanted. In his mind, management fees have been inordinately high.
A major concern is that, while the payout has been maintained at an excellent level, without the increase in the capital base that has swollen the number of units from just over eight million to almost 68 million today, there is no way those dividends would have been paid. He also questions whether they can be maintained. If the rate is reduced, the unit price will likely plummet from the current $11.10 level.
Besides some concerns about Algonquin itself, another reason for his sale was that, as a general rule, investment trusts are at their zenith in a low-interest-rate environment. However, when rates turn higher, they become less competitive relative to other vehicles, and their average price in the marketplace drops. While Canadian interest rates might still dribble downward, the tariff is within a hair's width of the bottom.
Another possible danger trusts face is whether government will change the tax laws that currently make this sector advantageous to investors, while diverting potential income away from the public purse. If this comes to pass, this field will tumble faster than one can say "Gagliano."
However, the other Contra Guy is more sanguine on Algonquin's prospects. He believes that Ontario Premier Dalton McGuinty's ambitious plan to shut down all coal-fired plants by 2007 will increase demand for hydroelectricity and other alternatives. In addition, he notes, water levels have been down, and as they rebound to normal levels, Algonquin's profitability should increase.
While he recognizes that trusts as a whole will not perform well when interest rates go up, he suggests that they will be separated into goats and sheep. According to this theory, Algonquin will be one of the fine-looking sheep.
Finally, it is difficult to find places to obtain a handsome return. With income alternatives few and far between, Algonquin is a decent place to park some funds.
So the truth is out -- the Contra Guys are not conjoined at the brain. However, we do believe that it is the combination of diversity and agreement that makes us stronger.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter. This column first appeared on GlobeinvestorGOLD.com.