Preferred share ETFs are showing signs of being a refuge for income-seeking investors worried about what rising rates will do to their portfolios.
Preferreds as a group were at one time as vulnerable to rising rates as bonds and utility, pipeline, telecom and real estate stocks. But the preferred share world is now mostly made up of rate-reset shares, which adjust their payouts every five years to keep up with interest rate ups and downs.
We’ve seen a dramatic increase in bond yields in the past year that has weighed heavily on the share price of bond ETFs and dividend stocks, notably utilities. Preferred share ETFs have been comparatively strong. The BMO Laddered Preferred Share Index ETF (ZPR) produced a total return of 5.6 per cent for the year to April 30, the Horizons Active Preferred Share ETF (HPR) was up 6.3 per cent and the iShares S&P/TSX Canadian Preferred Share Index ETF (CPD) was up 4.6 per cent.
BMO Asset Management said in a recent update on ZPR that it believes a good portion of rate-resets are trading below market value based on current five-year Government of Canada bond yields. BMO also noted that the supply of new shares coming to market has slowed in recent months, which may help stimulate demand. At current share prices, you can still get a strong yield from preferred share ETFs. ZPR’s yield was 3.9 per cent in mid-May, while HPR was around 3.8 per cent and CPD was at 4.3 per cent. Even after surging over the past 12 months, the five-year Canada bond yields just 2.3 per cent or so.
Mind the risks in a preferred share market dominated by rate-resets. If the economy stalls and bond yields fall, expect preferred shares and the ETFs that hold them to fall sharply in price. This is exactly what happened after rate resets were introduced following the last recession. The expectation was that rates would climb from there, but the opposite happened. Fearing their rate resets would be adjusted lower, investors sold these shares en masse. This debacle is reflected in the five-year result for ZPR — an annualized loss of 0.8 per cent.
Rate resets were designed for just the sort of rising rate world we’re seeing now. So far, they’re holding up nicely.
Rob Carrick