Time to tighten rules for business trusts?

Time to tighten rules for business trusts?

SINGAPORE - Eleven business trusts had been launched on the Singapore Exchange since the first one - Pacific Shipping Trust - hit the market in May 2006.

That maiden business trust on SGX has since been taken private.

And then there are 10.

How has this asset class done so far? Not good at all.

Of the 11 business trusts, only two - Pacific Shipping Trust and K-Green Trust - made money for their unitholders who got in at the initial public offering stage.

But even for these two trusts, unitholders would have done better just investing in the Straits Times Index.

Pacific Shipping underperformed the STI by 3.8 per cent a year, and K-Green by 4.8 per cent.

The worst performer is Indiabulls Property Trust, followed by the two remaining shipping trusts - First Ship Lease and Rickmers Maritime.

Overall, on average, a unitholder who bought into these trusts at IPO price would have lost an average of 23.4 per cent.

This is after taking into consideration the distributions if any.

The average underperformance relative to the STI is a whopping 11.5 per cent a year.

Hence the indisputable conclusion: business trusts have not been a rewarding asset class for investors so far.

Compare them with another type of trusts - real estate investment trusts (Reits) - and the performance of the two cannot be more different than night and day.

What could cause the vast difference in the performance of these two types of business structures?

Is there something inherent in the rules of business trusts that favours the sponsors over investors?

Well, yes.

Business trusts are managed by trustee-managers.

Under the Singapore Business Trusts Act, the trustee-manager can be removed only if 75 per cent of unitholders vote in favour.

At a discussion organised by CFA Institute's Standards and Financial Market Integrity committee last week, numerous participants noted that for sponsors, business trust is "a ready structure to exercise their control disproportionate to their cashflow rights".

Sponsors can sell off 74 per cent of the value of the assets, and still retain full control via the trustee-manager.

In Reits, the manager can be removed by a simple majority of unitholders' vote at a general meeting.

Business trusts also have fewer restrictions which allow them to do a lot more things and hence make them riskier.

They can hold various types of assets, like real estate, infrastructure assets or ships.

Some, like ships, may not have any meaningful terminal value. For real estate, they can undertake development as well.

On the other hand, Reits can only hold income yielding real estate.

On the borrowing front, there are no limits for business trusts.

The gearing for Reits, meanwhile, is capped at 35 per cent, or up to 60 per cent if it obtains, discloses, and maintains a credit rating from rating agencies.

In terms of distribution, business trusts are not required to distribute any dividends. They may pledge to distribute a certain percentage of income as dividends, but this can change.

As for Reits, they must distribute at least 90 per cent of income to enjoy tax transparency under Income Tax Act.

The less rigorous regime of the business trusts allows sponsors to exercise their boundless creativity.

Caveat emptor is a fair argument to make in a market populated by highly sophisticated investors.

In Singapore, the average investor is far from being sophisticated.

Given their atrocious performance thus far, there is a strong case for rules to be tightened for business trusts.

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