After two gory corrections in the past eight years, we can safely dispense with any ideas about how safe preferred shares are.
While the dividends that preferreds pay have for the most part been quite secure, share prices have shown a periodic tendency to plunge dramatically. Prefs got slaughtered in the crash of 2008-09 on fears about the financial system imploding, and they were hammered last year because of interest rate concerns. This is quite a lot of drama for a security that was once known as a widows-and-orphans vehicle for generating low-drama dividend income.
Avoid preferred shares then? Not necessarily. In fact, now may be the time to start buying. In a recent note to clients, the independent analyst Harry Levant of IncomeResearch.ca argues that the preferred market may have bottomed late in 2015. His suggestion for locking in a solid yield and possibly profiting from a rebound in prices is to buy an exchange-traded fund called the iShares Preferred Share Index ETF (CPD-T).
CPD lost about 15 per cent last year on a total return basis because, like the pref market itself in Canada, it's dominated by rate reset shares that are designed to protect investors against rising interest rates. When rates fell last year, rate resets lost all appeal. Mr. Levant said the bottom for rate resets may have been reached in November when various issues came to market with more favourable reset terms for investors. For example, some non-bank issuers offered a minimum rate guarantee. These new shares settled the market and helped propel the S&P/TSX Preferred Share Index 7.5 per cent higher in the final two weeks of 2015.
Mr. Levant notes that CPD wasn't a great choice last year because its portfolio weights rate resets more heavily than the fixed-rate preferred shares that held up comparatively well. With rate resets looking like they may have hit bottom, CPD becomes more attractive.
The distribution yield for CPD in early January was 4.95 per cent. That's 4.5 per cent on an after-fee basis, which is roughly double the yield on a 30-year Government of Canada bond. Safe, preferred shares are most assuredly not. But they do have rebound potential now, and a pretty fine yield as well.