The boss just came by and asked if I knew of any good books on investing in preferred shares, but I’ve never looked into it. Anybody here know of anything? We’re Canadians, but I’m sure any reputable material would be welcome.
I’d be surprised if there is a whole book on prefs. It’s pretty straight forward stuff. Canada also has some interesting conventions so some things would be different than an international book. Reality is investment grade prefs are much like bonds, and a lot of the work analysing them is similiar. Just different taxes and of course they are subordinated.
There are plenty of great fixed income portfolio options with prefs in Canada right now if you want stuff with limited duration but yet decent yield. Focus on rate resets as perpetual prefs right now seem like a pretty dangerous trade long-term. Pipelines offer good yield and IMO pretty solid security.
to elaborate on geo’s comment, you don’t get much credit spread from preferreds issued by financials but the spread is quite significant for non-financials. the retractable space will essentially disappear within 3 years which is sad because there are a lot of attractive retractables right now that offer 200-300 bps above a risk-free option on a two year holding period with minimal risk. agree with geo that the pipeline fixed resets (particularly the high reset fixed resets) are among the most attractive out there. also, AIMIA has always offered what i think to be an unjustifiably high yield though this yield is being squished lately.
Interesting, I’ve never really given preferreds much thought but after this morning I’ve been seeing some that pay out a 4-5% (pipelines) yield. I have no idea if that’s a good deal but seems decent from a risk management perspective.
So let me get this straight- preferreds are essentially the same as bonds in that the dividend (coupon) is fixed, possibly on some reset schedule and/or with embedded options, but basically just not open to discretionary changes like a common dividend would be, and that’s the major draw? Predictable cash flows with a slightly better spread than bonds due to the subordinated claim.
Well, the option not to pay the dividend is kinda discretionary. Sometimes preferreds have to pay back skipped dividends, sometimes they don’t. But there’s always an option to skip the dividend with a preferred. Presumably preferreds of dividend-paying companies have a premium price, because it’s more consequential for more capital-holders when they skip the preferred dividend.
Are preferreds really low-duration instruments? I never stopped to think about the calculation, but intuitively I would assume that their duration should be somewhere between long-term bonds and stocks. A 5% preferred presumably has a duration somewhere around 20, which doesn’t seem low to me.
You’ve kind of got it. Pref shares have preference (go figure) to common shares in dividends and liquidation. But they are subordinate to debt. Non-cumulative pref shares can have their dividends skipped in the event of some kind of payment trouble. Cumulative pref shares can also have their dividend skipped, but the missed dividends are still owed to the pref holder and must be paid BEFORE common dividends are paid.
Then you’ve got your differences in duration. Perpetual prefs exist forever at a certain rate. This is a monster duration instrument obviously, and probably something I’d stay away from today unless you believe rates will be low forever. Retractable prefs the company can buy back at various periods, sometimes at a premium.
Rate resets are common in Canada, kind of the structure of choice for new origination today. Every 5 years (or whatever) they reset to the Canada 5 Year + fixed spread, or they are redeemed at par by the issuer. Since many of these were issued at high spreads in the past, lots are getting called. Either way, you’ve got some protection from increases in the underlying GoC rates.
Also, these are eligible dividends so they’re taxed much more favourably than bonds.
If you compare what TransCanada, for example, pays on its 5 year rate reset prefs versus what it pays on a 5 year bond, you’ll see there is plenty of juice there. PLUS you get the tax benefit. Pure gold.
Ah, gotcha. Floating preferreds presumably have little duration, but the spread must be kinda small, too, yes?
^ One example I have pricing for handy (yields approximate, I don’t warranty data provided, do your own research, I have no opinion on ENB or the suitability for your portfolio or whatever, etc. etc., full disclaimer):
Enbridge Series R Preferred Shares, Reset date June 1, 2019 - Current Yield: 4.17%
Enbridge Senior Bonds 12Nov2019 4.490 coupon - Current Yield: 2.33%
You’re getting paid double after-tax for the subordination feature and a bit of spread risk. Yummy.