It was another choppy day for Canadian royalty and income trusts. Trusts that are largely unaffected by the proposed tax changes appear to be getting some traction. Meanwhile, affected trusts continued to head lower.

In Flash Alerts yesterday and Friday, I outlined a tacking move in my trust investing strategy. First, I want to build a conservative core of high-yielding trusts backed by solid businesses that are unaffected by the proposed tax changes.

On Friday, I began to transition the formerly named Top 10 into a broader Conservative Portfolio by moving exempt Algonquin Power (APF.UN, AGQNF), Atlantic Power (ATP.UN, ATPWF) and Boralex Power (BPT.UN, BLXJF) in and swapping out volatile and nonexempt Precision Drilling (PD.UN, NYSE: PDS) to the Aggressive Portfolio.

I followed that up in yesterday’s Flash Alert by adding two exempt trusts: Frequent Canadian REIT recommendation Northern Properties (NPR.UN, NPRUF) and “straddle share” Primary Energy Recycling Trust (PRI.UN, PYGYF) to the Conservative Portfolio. And I plan to add more exempt trusts to the Conservative Portfolio going forward.

The other part of my strategy is to decide which to hold of the battered trusts affected by the tax changes. Thus far, I’ve held onto pretty much everything and have been punished for it. Damage today was particularly severe among energy producers, as investors worry about what will happen to oil and gas prices this winter.

As we pointed out in this week’s Maple Leaf Memo, the simple litmus test for a battered trust is simply this: Would it still be an attractive holding if the dividend you now receive net of Canadian withholding were cut 26.5 percent? That’s essentially the additional amount of tax on trusts’ distributable income beginning in January 2011.

If you can honestly answer “yes” to that question, then you have no business selling. That’s because the trust’s price already factors in the absolute worst case scenario on taxes and then some. In other words, even if the taxes were raised today and the trust cut its distribution to reflect it, your trust would still pay a yield you’d be satisfied with.

When I look down the list of Canadian Edge Portfolio picks affected by the ruling, I see the following:

• Altagas (ALA.UN, ATGUF)—8.5 percent
• Bell Aliant (BA.UN, BLIAF)—9.7 percent
• Keyera Facilities (KEY.UN, KEYUF)—8.3 percent
• Newalta Income (NAL.UN, NALUF)—8.9 percent
• Pembina Pipeline (PIF.UN, PMBIF)—8.5 percent
• TransForce Income (TIF.UN, TIFUF)—11.8 percent
• Yellow Pages (YLO.UN, YLWPF)—8.5 percent
• ARC Energy (AET.UN, AETUF)—11.9 percent
• Avenir (AVF.UN, AVNDF)—14 percent
• Essential Energy (ENS.UN, EEYUF)—19 percent
• Fording (FDG.UN, NYSE: FDG)—22.1 percent
• Harvest Energy (HTE.UN, NYSE: HTE)—17.7 percent
• Paramount Energy (PMT.UN, PMGYF)—19.1 percent
• Peak Energy (PES.UN, PKGYF)—18.8 percent
• Penn West Energy (PWT.UN, NYSE: PWE)—12.4 percent
• Precision Energy (PD.UN, NYSE: PDS)—14.6 percent
• Vermilion Energy (VET.UN, VETMF)—6.6 percent

With the exception of Vermilion–whose low payout ratio and low debt make it virtually adjusted to a corporate format already–the rest of these are all yielding well above what they should were the tax change to tax place immediately. Moreover, all continue to grow their earnings rapidly, as we’ve pointed out in the trust updates in Maple Leaf Memo. The only exception is Fording, which is hostage to slumping metallurgical coal prices.

As I’ve pointed out, the oil and gas trusts will continue to be affected by oil and gas prices. For example NAL Oil and Gas (NAE.UN, NOIGF)–a medium-grade trust I’ve recommended–this week announced a dividend cut in response to falling oil and gas prices.

No trust to date, however, has taken any kind of precipitous action with its dividend in response to the proposed taxation changes. As NAL’s representative assured me today, no one he knows of has that intention either. Rather, they’re going to wait to see how things play out before they take action on that basis.

As investors, that’s exactly what we should do as well. The daily trading remains very tough to take and I confess I don’t have a crystal ball. I can’t say prices won’t go lower still. But if the worst case still looks good–a 26.5
percent lower dividend–there’s no reason not to stick with good trusts.