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rob carrick

Rob Carrick

A happy but overlooked investing story of the past year is the rebound in preferred shares.

The S&P/TSX preferred share index was up 18.4 per cent for the year to Jan. 13, a good start on erasing a few years of pure misery for the sector. The cumulative three-year loss for the index was 15.7 per cent, even after the rally of the past 12 months.

The plunge in preferreds represented a buying opportunity that was highlighted in a Portfolio Strategy column published last February. Let's revisit that column for some thoughts on what investors should do if they bought preferred shares at depressed prices a year or more ago. Dustin Van Der Hout, a portfolio manager with Richardson GMP in Toronto, highlighted three preferred share issues that have moved up nicely over the past 12 months:

- Brookfield Asset Management Series 24 (BAM.PR.T): Up 28.1 per cent to $17.96

- Royal Bank of Canada Series AZ (RY.PR.Z): Up 21.7 per cent to $20.17

- Toronto-Dominion Bank Series 5 (TD.PF.C): Up 21.5 per cent to $19.78

All of these shares are a type of preferred called a rate reset. Rate resets were designed for a rising rate world – their yields are reset every five years using a spread over the five-year Government of Canada bond. Rate resets were shunned a year ago because it seemed interest rates were headed lower. Now, with government bond yields on the rise, they're suddenly attractive again.

Mr. Van Der Hout said he recommended rate resets to clients mainly for a capital gain. After the price increases of the past year, he has sold three-quarters of the pref shares his clients held. The remaining quarter is held by people who want to continue to receive the very good yield offered by rate resets based on current prices and dividend payments. The Brookfield shares have a yield in the low 6 per cent range, and the two bank issues are just below 5 per cent.

Why sell when sentiment has decidedly turned in favour of rate resets, the most common form of preferred share? Mr. Van Der Hout wonders if investors are overly confident that interest rates will continue to rise. "The completely bearish view a year ago was overdone," he said. "We have a completely bullish view today, and I think prefs have probably got ahead of themselves."