The stock market is turbulent and safe government bonds yield almost nothing, leaving investors with few obvious options right now.
But there's one cash-gusher that deserves a closer look: the high-yielding preferred shares that Canada's big banks have been issuing over the past several months without much fanfare.
It's time to take notice. These shares yield a dazzling 5.5 per cent, an eye-popping figure in an era during which the five-year Government of Canada bond yields just 0.7 per cent.
Equally enticing, the banks will reset the yield on the shares every five years at a similarly wide spread over government bonds, leaving you with attractive dividend payments no matter which way interest rates go. The cherry on top: Preferred shares have a tarnished image, making today an ideal time to wade into this corner of the fixed-income market.
For the uninitiated, preferred shares are usually seen as an investment that lies between stocks and bonds. Like bonds, they pay a fixed dividend for a specified period of time. Like stocks, they can be bought and traded easily, in relatively small quantities.
They've struggled over the past couple of years, though. That's because the yields on many preferred shares are reset periodically, using Canadian bond yields as a benchmark. As bond yields have fallen, so, too, have the yields on preferred shares, hitting share prices.
Exchange-traded funds that hold a basket of preferred shares reflect the carnage. The iShares S&P/TSX Canadian Preferred Share Index ETF has fallen 26 per cent over the past two years, leaving investors wary of these investments.
But recent bank issues are a different breed that should be far more stable. The big banks use preferred shares to boost their capital levels, and even though names such as Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal and Canadian Imperial Bank of Commerce are among the bluest of blue chips, they've had to entice investors with big yields and attractive reset terms.
One reason for their largesse is that regulatory changes have pushed them to issue NVCC shares, or non-viability contingent capital. These preferred shares convert to common shares if the banks need rescuing – meaning that investors, rather than taxpayers, are on the hook for bailing out the banks during a terrible financial crisis.
Is a crisis likely? No. And if one occurred, your preferred shares wouldn't be the only investments in your portfolio to get whacked.
Some of the NVCC preferred shares issued early last year were shoulder-shruggers. They yield less than 4 per cent and the reset rate five years out was set at less than three percentage points above the yield on the five-year Government of Canada bond.
Since then, the banks have been beckoning investors with better terms. In February, RBC issued preferred shares that yield 5.5 per cent, with a reset rate that is 4.8 percentage points above the five-year bond – which is more than double the reset rate on existing preferred shares.
Even if bond yields slide to a mere 0.2 per cent five years from now, you'll get a 5-per-cent yield when the rate is reset. In other words, investors are insulated from low or falling interest rates, which is a nice touch when the Canadian economy is struggling and the Bank of Canada is in no hurry to raise its key rate.
There is one catch: The banks can redeem the shares after five years if they want to. Nonetheless, savvy institutional investors have been snapping up these new issues, and smaller investors can get a piece of the action as well.
While exchange-traded funds are a popular choice, direct ownership looks like a better option because it allows you to focus on the banks' new-and-improved preferred shares and avoid the less attractive ones (and ETF fees).
Okay, bank preferred shares aren't exciting. But their yields easily beat bonds, and the shares themselves won't wobble like the stock market, giving them an allure that's hard to resist.