Apr

13

I have been partially invested in Canadian Royalty Trusts for 2 years that have returns above the risk free rate.

Does anyone have any opinions or insight into this type of investment?

From what I've read their high return rate seems secure as long as oil is above $50/ bbl.

Alan Millhone gives a quick assessment:

Oil above $50 ?  I suspect you are safe for decades! 

Stefan Lewellen replies:

I know nothing about Canadian Royalty Trusts, but I can recall many instances in the past where a seemingly "risk-free" investment offering high returns has actually led to heavy losses.

One must remember that as the price of oil drifts higher, the economic story behind developing alternative energy sources becomes more and more compelling. These projects may not make any economic sense at $50/bbl, but at $150/bbl they may be quite profitable. At some point, such substitutes (or some other new development) will reduce the demand for oil – and oil prices will decline appropriately. Whether this happens in six months or twenty years is anyone's guess, but the fact that there is some non-zero probability that prices will fall below $50 makes this a strictly risky investment (in my opinion). If the probability of low oil prices is extremely small relative to the return premium over the risk-free rate, this could still be an excellent investment – but I'm not sure I would classify it as an investment of the risk-free variety.

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