Making a Case for Covered Writing Trusts

Despite wrong perception that distribution is guaranteed, these investments can be attractive

Article by Richard Kraft

Much has been said and written about the problems associated with covered writing trusts. Most of the discussion has been negative, particularly with principal-protected covered writing trusts. The talk centres around their ability to deliver the targeted income as defined in the prospectuses.

Analysts who follow the principal-protected covered writing trusts evaluate them in terms of their performance thresholds, defined as a fund's "hurdle rate." That is the minimum return the fund must achieve to deliver the distribution target.

This pint is crucial. One of the problems is the perception among investors that the distribution is guaranteed. The income objectives are targets not guarantees. The only thing guaranteed with these structured products is the return of principal either 10 or 12 years from date of issue.

This discussion took centre stage recently when Mulvihill Capital Management Inc. vice president Donald Biggs resigned. Biggs was a main player in Mulvihill's structured-product division. At the same time, Mulvihill, the leading investment company marketing covered-call writing products, announced that it would be cutting the distribution rate on a number of its principal-protected covered-call writing trusts. In one case (the Pro-AMS U.S. Trust - symbol: PAM.UN) to 4% from 9%; in another (the Pro-AMS Trust - symbol: PR.UN) to 6% from 8.75%. Mulvihill is one of the last managers to announce distribution cuts to its principal-protected covered writing line of funds. For those who have yet to cut distributions, look for them to follow in the near future.

Before going further, there are three points readers should know:

I act as a sub-advisor on two exchange-traded principal-protected covered writing trusts: the Sentry Select Blue Chip Income Trust and the Sentry Global Index Income trust;

I manage the Croft Enhanced Income Fund, an open-ended (as opposed to a closed-end fund such as the ones listed on the Toronto Stock Exchange) covered writing fund that does not offer principal protection, and;

Readers can read previous articles on this subject by going to www.croftgroup.com

There are two issues for brokers:

It is important that you discuss with clients the current situation within the context of other investment alternatives; and

Can you make a case for buying covered writing trusts now at their current price...