Oil-and-gas royalty trusts don't fit the profile. Leveraged to oil and natural-gas prices, they can be unpredictable both in terms of paying steady distributions and the day-to-day performance of their unit prices. So why buy them? In a word, yield. Royalty trusts pay the fattest cash yields in the income-trust universe—as much as 13 to 18 per cent.
Asset quality: Ideally, a royalty trust should control a portfolio of oil and gas properties with abundant reserves and a low decline rate. Specifically, you'll want to take a look at the reserve life index, or RLI, which is calculated by dividing reserves by annual production volume. Mr. Tait said there are many royalty trusts with an RLI in the nine to 11 range, which is quite reasonable.
A balance between oil and gas properties: Oil and gas prices tend to move in different patterns. By finding a trust that mixes the two, you'll have diversification that will offer a measure of protection if one or the other tanks. "If you were going to buy one trust, you'd want to make it one that was pretty balanced," Mr. Tait said. "But if you're buying a portfolio of trusts, you can buy a really gassy trust and mix it with a really oily one and get your gas-oil balance that way."
Management: The test here is how effectively management has added reserves at a reasonable price. Check to see if the trust has been able to increase reserves and production without issuing a lot of dilutive equity.
Payout structure: Roughly 80 to 85 per cent of cash flow will likely go to pay distributions, with the remainder being tabbed for capital expenditures so additional equity does not have to be issued. A higher payout ratio is not a good sign.