As little as four years ago, Rob Lauzon, managing director of trading at Middlefield Capital Corp., only owned income trusts in the closed-end MINT Income Fund. However, since federal Finance Minister Jim Flaherty announced tax changes for the popular investment vehicles on Oct. 31, 2006, the fund has broadened its income focus to include dividend-paying stocks such as BCE Inc. and Canadian banks, as well as high-yielding bonds and convertible debentures.

Instead of withering in the absence of income trusts, Mr. Lauzon thinks income-seeking investors may actually see their opportunities expand. In addition to dozens of income trusts that will convert to high-yielding common shares, he suggested that companies such as EnCana Corp., Suncor Energy Inc., Canadian Natural Resources Ltd. and Potash Corp. of Saskatchewan may ratchet up their dividends in order to take advantage of the gap left by income trusts. This will also allow them to better cater to an ageing population of investors. Meanwhile, income trusts that might have been shunned by institutional money managers may get a fresh start in their new corporate form.

"I'm pretty excited about my investment universe here," Mr. Lauzon said. "It's been quiet for a while, but it will come to life again."

Canadian income trusts still have a year until their distributions will face the same tax rate as corporations, but investors and companies continue to make the adjustments that began when Mr. Flaherty revealed his decision on Halloween 2006. Markets immediately began the process of weeding out income trusts capable of surviving the conversion as high-yielding dividend stocks from those incapable of doing so.

The big question for investors is how management at each individual trust will view their businesses. Will distributions to investors remain a top priority or will companies reinvest their cash flow in order to grow the business?

"I think there are a number of options for them, but clearly there is another obligation for their cash flow, other than capex and distributions," said Glenn MacNeill, chief investment officer at Lawrence Asset Management.

He noted that many trusts have held back on distribution increases in anticipation of turning into corporations. If they eventually have to cut their dividends, then the drop won't be as dramatic. "They are keeping some of their powder dry," Mr. MacNeill said, adding that some of that distribution stream in the form of dividends will be taxed at a lower rate for individuals. As a result, he sees it as a wash in the long run.

While investors will receive a likely smaller distribution (reduced by the amount of the tax paid by the income trust), it will be taxed as a dividend in non-registered accounts. The portfolio manager also noted that from a cash-flow standpoint, many companies have tax-sheltering ability. Therefore, some won't have to pay the additional taxes for a year or two.

David Graham, vice-president and portfolio manager at CIBC Asset Management, highl ighted Northland Power Income Fund as one company that thinks it can shelter its taxes until 2014 or 2015. While the owner of interests in several power-generating facilities may only have modest growth prospects, he is happy with its 9% yield.

By the second quarter of 2010, investors will have firmer guidance on the strategic direction of trusts that have yet to convert, according to Mr. Lauzon at Middlefield. Until then, it remains difficult to know what will happen to distributions, particularly as payout levels in the energy sector are largely dependent on oil and natural gas prices.

"A lot of names are dependent on energy prices, so it's tough to make a blanket statement as to whether distributions will be cut or increased," he said.

Mr. Graham noted that some oil and gas trusts plan to take part of their distribution and put that money into capital spending. "If they are an income trust that really doesn't have a big use for the money, then I guess they'll keep paying a dividend," he said.

Advantage Oil & Gas Ltd., which converted from a trust in July, suspended its distributions earlier in the year. It saw better uses for its cash flow in the form of capital expenditures and debt repayment. Others like Davis + Henderson Income Fund might not have a use for this cash since it is difficult to find acquisitions in its financial-services niche and the company may find it difficult to grow at a faster pace than it already is.

David Baskin, president of Baskin Financial Services Ltd., says that by and large, investors still have a variety of different investment baskets to choose from despite the demise of income trusts. Real estate investment trusts or REITs, which are exempt from next year's conversion, are a likely alternative to income trusts, and so too are preferred shares and convertible debentures, he noted. But it is the traditional high-yielding Canadian stocks such as the banks, BCE, TransCanada Corp. and Enbridge Inc. that Mr. Baskin figures are likely to get the biggest bang in the coming years.

"I think we will see renewed interest in old-fashioned buy and hold investments," he said. "They are not that sexy, but the dividends are tax protected, they have very strong track records of increasing their dividends regularly, and with strong balance sheets, it is unlikely they will miss a payment."

jratner@nationalpost.com