The most common type of preferred share is developing a reputation for being a liability when interest rates are falling.
Don’t entirely write off rate-reset preferreds in a falling rate world, though. A small slice of the rate-reset market offers a minimum dividend, a sweetener that helps these shares weather rate declines better than other rate-reset shares.
Preferred-share specialist John Nagel of Leede Jones Gable said there are about 30 minimum dividend rate-reset preferred-share issues, which amounts to between 12 per cent and 15 per cent of the preferred-share universe he follows.
“These shares have a relatively low sensitivity to interest rates,” he said. “If interest rates go down, which they have, you have something to rely on – a floor.”
Rate-reset preferreds were invented about 10 years ago, when there was an expectation that interest rates would rise sharply from the historic lows of the day. Resetting the dividend every five years was thought to be a way to help investors get the benefit of rising rates. Rates never did spike higher – in fact, they have frequently fallen. The net result is that rate resets have, in some cases, had their dividends adjusted lower, not higher, and share prices have fallen hard.
Here’s how the minimum dividend defends against a lower dividend: At each five-year reset of the dividend, investors get the greater of the five-year Government of Canada bond yield plus a premium or a floor yield. The floor ranges roughly from 4.5 per cent to 6.5 per cent in the minimum-dividend rate-reset universe, with higher floors offered by companies with weaker credit ratings.
To provide a sample of what’s available in minimum dividend rate-reset preferred shares, Mr. Nagel highlighted five different issues. Let’s zero in one of them, BAM.PF.I, from Brookfield Asset Management. At reset on March 31, 2022, the dividend would be pegged to the greater of the five-year Canada bond yield plus 3.85 per cent or a floor of 4.8 per cent.
Over the past year, BAM.PF.I’s share price has fallen about 5.4 per cent, and in early September was trading just below its $25 issue price at $24.65. Exchange-traded funds holding a broad spectrum of rate resets or preferred shares of all types have fallen roughly 18 per cent to 20 per cent in the past year.
The other minimum-dividend rate resets highlighted by Mr. Nagel were issued by:
- Brookfield Office Properties (BPO.PR.C)
- Enbridge (ENB.PF.I)
- Pembina Pipeline (PPL.PF.A)
- TC Energy (TRP.PR.K)
There are no ETFs tracking minimum-dividend rate-reset preferred shares, so investors will have to buy individual securities. One way to find them is to find a non-financial issuer you’re interested in and then check their list of preferred share issues to see if any have a minimum dividend at reset time.