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It has been a roller coaster ride for most financial market securities in recent years, particularly for preferred shares.
Preferred shares – a hybrid security with equity and fixed-income features – were hit harder than some other securities in 2022 as investors fled from investments sensitive to soaring interest rates.
The S&P/TSX Preferred Share Index was down 14 per cent for the 12 months ended March 15, compared to a drop of 5.6 per cent for the S&P/TSX Composite Index over the same period, according to S&P Global total return data. Both indexes are flat year-to-date as of March 15.
Some investors believe preferred shares are poised to recover, given attractive valuations and improving credit conditions.
They also point to the benefit of cash flow from preferred shares being taxed more favourably as dividend income compared to the treatment of interest income.
Globe Advisor spoke recently with Nicolas Normandeau, vice-president and portfolio manager for fixed income at Fiera Capital Corp. in Montreal, about the preferred share market.
Describe preferred shares in a bit more detail.
There are three main types of preferred shares: fixed-rate, where you get the coupon rate and are stuck with that rate unless it’s called; floating-rate, where rates move along with interest rates; and fixed-reset, where you get a coupon for, say five years, and after that, the issuer can call it. If they don’t call it, you are extended for another five years at a new coupon rate. Fixed resets are the most common, accounting for about 75 per cent of the preferred share market.
What’s behind the volatility of preferreds in recent years?
It was a tough environment for preferred shares when the pandemic started in early 2020. At one point, the preferred market was down by about 30 per cent. When the Bank of Canada cut interest rates, it was negative for the fixed-reset preferred shares. The credit environment was difficult, and spreads were widening, which led to a lot of selling.
That trend reversed quickly in 2021, alongside the equity markets and the credit tone. What also helped was that the banks and life insurance companies began issuing Limited Recourse Capital Notes (LRCNs) instead of preferreds. It was positive for preferreds because it created some scarcity as some issuers started redeeming their expensive preferred shares.
Then, in 2022, the rapid pace of central banks’ interest rate hikes affected the credit environment negatively and, more specifically, the instruments below in the capital structure, like LRCNs and preferreds, which led to more selling. This higher-rate environment reduced the weakness, particularly for fixed-reset.
What’s your outlook for preferreds this year?
It has been a good start to the year. Spreads are tightening and rates are increasing a little bit from December levels. The average yield is getting more attractive, and there’s a huge potential upside on your average coupon. If the five-year rate stays high, investors can reset with a much better coupon. The real reason to buy preferreds is for the upside – if rates stay high or go higher – which isn’t impossible.
What’s your advice for investors looking to buy preferreds?
When you buy this asset class, you should expect volatility. It’s a small market. You don’t want all of your fixed income in preferreds, but it can help balance out a diversified portfolio.
This interview has been edited and condensed.
- Brenda Bouw, Globe Advisor reporter
Must-reads from Globe Advisor this week
What to watch out for when companies offer dividend reinvestment plans
Two of Canada’s big banks sweetened the pot for investors who prefer to take their quarterly dividends in shares rather than cash at the end of 2022. In November, Royal Bank of Canada RY-T tweaked its dividend reinvestment plan (DRIP) to offer a 2-per-cent discount to the market price for shares taken as dividends. A week later, Canadian Imperial Bank of Commerce CM-T announced the same 2-per-cent-off deal. The move was good for the banks and their shareholders. By creating an added incentive for investors to participate in their DRIP programs, the banks conserve capital. DRIPs make a lot of sense for investors if they don’t need cash dividends to live on. The purchases are free of fees and the compounding effect adds up. But it also matters which companies are offering the plans. Adam Mayers looks at the pros and cons of DRIPs.
Why agriculture commodities are a good long-term bet
The ongoing war in Ukraine and an increase in severe weather events worldwide continue to constrain the supply of key agricultural commodities and prop up prices, making the sector attractive to investors willing to stomach the regular market swings. Prices of many agriculture commodities dropped in the second half of 2022 due to a combination of rising costs amid surging inflation and extreme weather including droughts and floods, which reduced the number of acres planted. The levelling off of agriculture prices from last year’s record highs presents a good entry point for investors, say experts. Brenda Bouw gives an outlook for the sector and where the opportunities lie.
Why every advisor and practice needs an emergency plan
Clients depend on their financial advisors to help plan their retirement, create a solid investment portfolio and execute financial plans. But what happens if an advisor is hit by a bus? Will their clients be left in limbo? Whether you want to call it an emergency, catastrophe or business continuity plan, all advisors should have one, experts say. Unlike a succession plan that’s about transitioning leadership and ownership of a financial advisory practice, a documented emergency plan comes into play if an advisor suddenly can’t work or help clients. Kira Vermond looks at what needs to be considered in a plan and what resources are available.
What to consider before moving somewhere cheaper to retire
Selling a pricey home and moving to a cheaper location to stretch retirement dollars is tempting in this era of galloping inflation. But serious financial planning and an assessment of lifestyle factors are needed before making such a drastic move, advisors say. Even if housing and food are more affordable elsewhere, costs of insurance, dental treatments and airfare home to Canada to connect with family should be considered. The soft issues including leaving friends, family and clubs could also be too much of an upheaval for older retirees. Kathy Kerr speaks to experts about the factors that need to be weighed before deciding to make a move.
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Canadian funds take a hit on Silicon Valley, Signature bank stocks
Several Canadian mutual funds and institutional investors have taken a hit on U.S. bank stocks, particularly Silicon Valley Bank (SVB) and Signature Bank, the two institutions that failed last weekend. The government seizure of the two banks likely means their shares will fall to zero when they resume trading. And the shares of several other regional banks, previously believed to be healthy, tumbled by 30 to 50 per cent this week as U.S. regulators tried to halt the contagion. SVB, Signature and several of these banks are members of the S&P 500, which will trim returns on many broad U.S.-based equity funds held by Canadians. Clare O’Hara and David Milstead analyze the impact based on fund-specific data.
Why the long-term outlook for Canadian stocks is looking rosy (short-term, not so much)
The Canadian economy faces a challenging path forward, as the impact of higher interest rates is poised to weigh further on a highly leveraged consumer and an overextended housing market. In addition, with global recessionary pressures on the rise, Canada’s export dependency makes it vulnerable to external demand shocks. But there are also some reasons to be positive: The Bank of Canada’s interest rate hikes are now on hold, and inflation is showing more signs of going off the boil. Furthermore, the Canadian dollar is cheap by historical standards, and strong immigration flows will serve as a tailwind to long-term growth prospects. David Rosenberg and Brendan Livingstone explain why the selling pressure that equities face is a buying opportunity.
– Globe Advisor Staff