Seven months after the post-Halloween plunge, the minority Conservative Party government appears dug in as ever on taxing trusts beginning in 2011. But strong trusts across the board are definitely in rally mode, with the broad-based S&P TSX Income Trust Index moving back above pre-Halloween 2006 levels last month.

So far, oil and gas producers have been the laggards in the recovery. The reason: The year-plus drop in oil and gas prices prolonged and deepened their declines through the winter, as we saw some two dozen dividend cuts. Now even they’re starting to recover, including the badly battered gas-focused trusts.

The Aggressive Portfolio already lists one aggressive natural gas trust, Paramount Energy (PMT.UN, PMGYF). This month, I’m adding another: Advantage Energy Income Fund (AVN.UN, NYSE: AAV).

Until the last several months, Advantage Energy had routinely rated a sell in Canadian Edge. Since its inception in 2001, the trust has built a solid base of assets at reasonable prices, growing from an initial production base of just 7,300 barrels of oil equivalent (BOE) per day to more than 29,000 in the first quarter of 2007.

The problem has been execution. In fact, until the merger with Ketch Resources last year, the more Advantage grew, literally the less profitable it became.

The Ketch merger brought a new management team to Advantage and a chance for redemption under the leadership of incoming CEO Andy Mah. Mah had previously earned a solid reputation as president and chief operating officer of Ketch and promised to bring a more-disciplined approach to operating the trust’s 121.3 million BOE proved plus probable reserves base in western Canada.

At the same time, Advantage has faced an increasingly difficult operating environment; natural gas prices have literally fallen in half from post-Hurricane Katrina highs. Meanwhile, drilling costs have only recently begun to abate in the wake of the slowdown in activity, further squeezing cash flow.

As a result, Advantage has been forced to trim its distribution and—despite a mild recovery in recent months—the shares continue to languish. For its part, Bay Street remains negative on the shares.

That makes now an ideal time to get back into Advantage. Shares are cheap, trading at just 1.25 times a book value of assets that’s clearly trending upward.

The monthly yield is well more than 13 percent and is backed by a modest payout ratio of 76 percent of first quarter funds from operations. That’s down substantially from the 95 percent of a year ago.

More important, Advantage’s underlying business is in better shape than ever. Production volumes surged 64 percent in the first quarter, as the trust benefited from both the Ketch properties added from the June 23, 2006, merger and the success of the drilling program.

With nearly two-thirds of its overall output coming from natural gas production, Advantage remains heavily leveraged to gas prices. That was a severe drag during the past year. But it should be a major boon going forward.

With the market obsessing on weekly inventory numbers, gas prices near term are certain to reflect weather more than anything else. Long term, sharply higher prices are all but certain because of soaring use of gas to generate electricity.

Trusts like Advantage will have no problem selling all they produce at rising prices going forward. Output growth has come at the price of massive equity issues, including growth in outstanding shares of 93.4 percent in the past year.

Increases of that magnitude will be impossible going forward, in part because of limits set by the Canadian government. Mah’s team, however, has managed to take debt down to just 1.35 times annual cash flow, giving the trust more options for financing than ever, even as its large size makes equity deals easier as well.

Advantage also has another hidden strength: some $1.2 billion of tax pools, which it can use to shield income from the taxman in 2011 and beyond, if it is ultimately taxed as a corporation.

Before the Flaherty announcement, tax pools were useful for trusts because they sheltered what wasn’t paid out in distributions. After 2011, tax pools will be the key to avoiding future taxes, and no one is more loaded up on them than Advantage, thanks to Mah’s careful policy of maximizing them.

Moreover, tax pools will probably increase in the next few years because of expansion activity as well as a less-obvious reason: The trust maintains a high payout ratio, which means it has to use less tax pools to shelter income. A high payout ratio brings higher dividend risk when gas prices are weak, but it provides enhanced protection from future taxation.

As the Feature Article makes clear, tax pools aren’t widely understood and, for that reason, aren’t reflected in prices of trusts like Advantage. That’s another positive for the shares going forward. Aggressive investors should buy Advantage Energy Income Fund up to USD14, where it would still yield more than 12 percent.

Shareholders of closed-end mutual fund EnerVest Diversified Income Fund (EIT.UN, EVDVF) have been on a roller-coaster ride the past few years. In 2006, the fund broke a string of seven consecutive years of double-digit gains, dropping 17 percent.

Ironically, it held net asset value (NAV) remarkably steady over that time, a testament to management’s solid portfolio skills and focus on buying good businesses. The drop was due to a sharp shift in the market price from a double-digit premium to NAV to the current steep discount of 12.7 percent. That discount persists despite a more than 20 percent run-up in the shares thus far this year.

As the biggest closed-end fund of Canadian trusts, EnerVest’s size gives it considerable economy when it comes to controlling costs. The effective expense ratio is less than 1.2 percent of assets. That’s allowed it to continue paying an outsized yield during the past year, despite the wave of distribution cuts at oil and gas producer trusts (around 20 percent of holdings).

The current payout is roughly 140 percent of net investment income. The rest is mostly comprised of realized capital gains, which the trust is required to pay out each year. Of course, capital gains can vary widely from year to year. As a result, only investment income is a reliable source of funds.

A reduction in EnerVest’s distribution to only investment income would still leave it with a yield of nearly 9 percent. Moreover, the portfolio is exceptionally diversified and solid; it includes 17 Canadian Edge holdings.

I almost always prefer owning individual trusts to funds. When you make your own selections, you always know exactly what you have and what you’re going to get paid in distributions.

In contrast, funds are far more opaque. EnerVest does the best job in the industry of providing good information on its Web site and through our Canadian partner MPL Communications, which can be accessed through the How They Rate Table.

EnerVest has made a point of paying big distributions during the past several years, and management obviously intends to keep doing so. As long as distributions exceed investment income, however, there’s always the possibility of a cut.

Moreover, the trust has asked shareholders to vote on a proposal to allow it to own more debt and equity, including shares of corporations. The added flexibility will benefit fund performance long-term. But it could also mean lower distributions.

Distributions from funds, including EnerVest, are also considered ordinary income for US tax purposes, unless the investor is willing to file taxes as a Canadian would. Advantage’s distributions are wholly qualified income. EnerVest and Advantage are withheld at a 15 percent rate at the border, though that’s recoverable as a foreign tax credit by filing Form 1116.

Even with the tax disadvantages, however, it’s hard to go wrong buying good businesses already selling at bargain prices for less than 90 cents on the dollar and getting a double-digit yield in the meantime. EnerVest Diversified Income Fund is a solid buy up to USD7, at which it would still trade at a discount to NAV.

_{*Recent prices as of 06/06/07, close.}