Which guy is right?

Benj Gallander and Ben Stadelmann
Sunday, February 22, 2004

When he speaks publicly, one of the Contra guys likes to trot out a pat line: “Dividends allow me to be stupid longer.” This phrase has always been part of the Contra philosophy and it continues to hold true. If you buy a stock whose price goes down for years, but a dividend cheque keeps arriving in the mail, at least there is some financial return. With the dividend tax credit to boot!

A few years ago, when the focus was on technology and rapid stock price appreciation, dividends were considered the offal of investing. Since the evaporation of that Never Never Land, investment trusts have become the flavour of the day, and it seems as if everyone and their uncle are bringing one to market.

While many of these are worthwhile, others are overpriced from the outset and their business models are murky. Simply because something is labeled a “trust” by no means makes it trustworthy.

One that we bought outside the Contra portfolio was the Algonquin Power Income Fund; both of us were looking for diversification, for a platform to balance the nature of other investments.

Algonquin, an owner of numerous hydroelectric generating facilities, was desirable because it was a play on a renewable resource, as opposed to such non-renewable energy sources as oil and gas. Depletion of assets in many investment trusts is a concern.

While the two of us were in accord on all the reasons to purchase the company, our current attitudes toward it have diverged: one of us decided to sell all of his holdings, while the other only disposed of half. Hey, it happens in every partnership.

The one who sold his complete position had become disenchanted with the company. In his mind, management fees have been inordinately high, and rumours abound that the top brass’s spending habits are lavish.

A major concern is that, while the payout has been maintained at an excellent level, there is no way those dividends would have been paid without the increase in the capital base that has swollen the number of units from just over eight million to almost 68 million today.

He also questions whether the distributions can be maintained. If the rate is reduced, the unit price will likely plummet from the current level of $11.

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. 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 yet dribble downward, they are within a hair’s breadth of the bottom; a push in the other direction is all but mandatory.

Another possible danger that 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, as mentioned, the other Contra Guy is more sanguine about Algonquin’s prospects. He believes that the 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 hard 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.