There was news this morning that Canada is considering changing it’s tax laws regarding unit trusts. They’re proposing to remove the special tax status of the trusts (they’re similar to REITs in the US — they pay little or no corporate tax if they pay out a majority of their revenue for the year). As a result, the entire TSX income trust sub-index was down 12% in early trading today.

The trust status was being abused by some Canadian companies (i.e. a telephone company was about to convert to trust status), and the immediate consequences of the proposal would most affect new trusts — existing trusts can operate under the same tax situation for 5 more years.

This is particularly noteworthy because (a) I own a few shares of Canadian unit trust companies, and (b) this is a powerful reminder of some less obvious risks in the market.

While my portfolio has been sharply hit by this rather violet market action (my trust positions were down an average of 20% in early morning trading), it is not debilitating. I spread my positions around and limit the amount I put in any single stock or unit trust because of the possibility of just such an event.

While I jokingly titled this post “Blame Canada” after the South Park song, I certainly don’t blame them for my losses in the market today. I blame them for making bad political decisions (assuming you consider this proposal “bad”), but I invested knowing that there was a risk of sudden drops like this. Which brings me to my point… what can we learn from / be reminded of with this event?

  • Everyone in the market is at the mercy of arbitrary government decisions (normally called “political risk”), and it is not just limited to extremist governments like Venezuela — Canadian and US governments will act in ways that adversely affect our investments without warning.
  • Markets will overreact — the existing trusts aren’t affected by potential tax changes until 2011. It’s also just a proposal at this point, though I’m not sure if the change must be legislated or if it is just enacted at the will of the Minister of Finance.
  • Relatively unrelated companies can move in tandem (in the wrong direction) without warning.
  • News is not as easy to find in less mainstream investments like this — I had to go googling as Yahoo Finance, BigCharts, and Google Finance did not link any stories to my individual stocks/unit trusts.

And, to be fair, there was “warning” of this type of event occurring. The previous Canadian administration tried to do this and failed. So I was warned…

Regardless, the initial damage is done. I’m hoping that the Canadian government will see the drop in the markets as well as the large drop in the Canadian Dollar, and try to assuage the fears of foreign investors… If not, there will be quite a few investors singing along… “Blame Canada…”