Category: Press Clippings

Eric Lam of the Financial Post has published a piece titled Opt for dividend half of split-share companies in which I am quoted:

James Hymas, an expert on preferred shares and president of Hymas Investment Management, recommends preferred shares over capital shares. “The preferred shares are very often a good investment for a fixed income retail investor looking for a short-term investment. Capital shares are almost always a poor investment.”

While the investments carry a paper expense ratio generally between 1% and 1.5%, the fees are borne almost entirely by capital shareholders.

For example, if the underlying portfolio is worth $15 and preferred shareholders are guaranteed $10 on maturity, then capital shareholders only really have a claim on $5, but are paying fees on much more than that, he said.

Another factor to consider is that split preferred shares often receive very low credit ratings from credit agencies due to the multiplying risks involved in holding a basket of companies. However, Mr. Hymas argues that investors holding split preferred shares are still better off as investors in common or preferred shares in an operating company generally get nothing in the event of a default.
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For those interested, Mr. Hymas recommends investors look for annual yields of at least 4.5% or more. Deciding on credit volatility means taking a good hard look at the underlying portfolio.

Mr. Hymas is keeping an eye on two different preferred shares from BAM Split Corp. that carry shares in Brookfield Asset Management Inc. and must be redeemed by 2016 and 2019 respectively. Another is the preferred shares of Dividend 15 Split Corp. II, which holds 15 companies including the big five banks and telecoms such as Telus Corp. and BCE Inc. It matures in 2014.

John Heinzl has an article in the Globe & Mail of 2011-4-27 titled The case for, and against, real return bonds in which I am quoted:

James Hymas, president of Hymas Investment Management, said the low yields on RRBs suggest that some investors are worried about hyper-inflation. They would rather accept a tiny real yield than suffer a loss in purchasing power if inflation really heats up.

But he’s no fan of RRBs, either, partly because they’re less liquid than regular bonds but mainly because “they’re trying to do too many things at once. They’re trying to give you a fixed income and inflation protection, but they don’t perform either function particularly well.”

If investors want inflation protection, fixed-income portfolios are the wrong place to achieve it, he said. They should instead look to other asset classes, such as resource stocks, to counter the impact of inflation on their bonds, he said.

John Heinzl has written an article with the captioned title that follows up his earlier piece titled Ups and downs of doing the splits.

“Jim from Victoria” wrote in and said (among other entertaining things):

Also you failed to mention that the shortfall in dividend income for the capital shares is made up from writing covered calls, one of the most secure and safest types of income investing one can do IF you know what you doing.

I was asked for comment:

Regarding your point about selling options to generate income, I asked split-share expert James Hymas of Hymas Investment Management to comment generally on the strategy of writing covered calls to fund dividends on the capital shares. (When an investor writes a covered call, he earns cash in exchange for granting the right to another investor to buy his shares at a specific price on a certain date.)

Here’s what Mr. Hymas had to say: “There does not appear to be any support for the claim that the strategy is doing anything useful at all for the split share corporations. None of them break out their books in sufficient detail for an assessment to be made; none of them or their subadvisers provide any actual performance data to support such a claim.

“The only thing that can be said for [selling covered calls] is that it will produce income, at the expense of potential capital gains. There is a tradeoff there.”

John Heinzl’s Investor Clinic in the Globe is titled Ups and Downs of Doing the Splits and addresses the question: What are split shares exactly, and are they a good investment?

He starts of really well:

Because split shares can get a bit tricky, we’ve invited one of Canada’s leading preferred share experts, James Hymas of Hymas Investment Management in Toronto, to share his expertise.

Dear Sirs: Please extend my Globe & Mail subscription …

Most of it’s pretty basic. My favourite part was when I was asked ‘Who buys Capital Units?’:

For those reasons, Mr. Hymas says the capital shares are only appropriate for “suckers.”

“They’re for people who like to pay high fees, and they’re for people who like to take a lot of risk, and they’re for people who can’t read a prospectus properly,” he says.

John Greenwood of the Financial Post wrote a piece titled Former darling hybrid capital still in limbo. I can’t say the published quote constitutes my deepest thinking on the subject, but it was nice to be mentioned:

The problem is that more than $3-billion of the capital was raised in the form of innovative Tier 1 instruments or hybrid capital around the crisis but under pressure from international regulators, the Canadian financial watchdog is forcing banks to redeem those securities well before they are scheduled to mature.

Result: Markets for these normally stable fixed income investments has whipsawed, even evaporated in some cases, leaving a few investors wishing they kept their money in their pockets.

“When the rules came out from [the Basel Committee on Banking Supervision] a lot of hybrid capital came under significant selling pressure,” said Todd Johnson, who helps manage about $100-million at BCV Asset Management in Winnipeg. (Mr. Johnson does not expect to lose money on his investment.)
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The Basel Committee, the top standard setter for banks globally, lays out broad policy but it’s up to national regulators such as Canada’s Office of the Superintendent of Financial Institutions to interpret and institute that policy.

However, for its part, OSFI has stayed mysteriously absent from the discussion, declining to provide any public guidance at all and increasing uncertainty — which of course is bad for markets. Greater clarity is expected shortly, possibly as soon as Friday.

“Basically, some of these holders are looking at large capital losses,” said James Hymas, president of Hymas Investment Management Inc. and editor of a popular internet blog on preferred shares.

For more, see BIS Finalizes Tier 1 Loss Absorbancy Rules.

I was recently interviewed for an article in Les Affaires, titled Actions privilégiées : jouez de prudence (translation below courtesy of Google):

Currently, they are perpetual preferred shares at fixed rates which offer the best performance. It averages 5.8%, says James Hymas, president of Hymas Investment Management. Adding the tax benefits of dividends, or by multiplying by 1.36, we obtain a bond yield of 7.89%. “However, corporate bonds long term, quite similar to those shares, provide an average yield of 5.5%. The gap of 2.39 points, which is above the historical average,” says he said.

I wrote an article for “Moneyville” in the Toronto Star titled 6 places to get the best return for least risk.

In it, I briefly describe six sources of income:

• GICs: Plain vanilla
• Bond ETFs: The best choice
• Preferred shares: Also a good choice
• Common shares: Not Fixed Income
• Bond Mutual Funds: High fees
• Individual Bonds: Also a bad idea

John Heinzl was kind enough to quote me in today’s Globe and Mail in his Investor Clinic:

I’m a retired and experienced investor. Some months ago I invested a sizable amount of money in preferred shares of major banks, the rationale being that it would be a safe haven for the cash and produce a steady stream of dividends. They have fallen sharply over the last few weeks. Why?

The facile explanation is that interest rates are rising, so straight preferred shares – which trade much like long-term bonds – are falling. But preferred share expert James Hymas of PrefLetter.com says the tumble in preferreds has more to do with emotion than interest rates.

Short-term rates are indeed rising – the Bank of Canada all but confirmed yesterday that it will hike its benchmark rate on June 1. But long-term corporate bond yields – which are far more important to the preferred share market – are not.

“Long corporate yields have been fairly steady. They have been bouncing around at basically 6 per cent to a little under for the all this year. So whatever concerns there might be about rising interest rates, they’re not being shared by the corporate bond market,” Mr. Hymas says.

So why are preferred shares falling while long corporate bonds are not?

The corporate bond market is large and dominated by institutional investors such as pension funds and insurance companies that take a long-term view. The preferred market, on the other hand, has a bigger retail presence and many issues are comparatively illiquid. This makes preferred prices more volatile, particularly when retail investors start getting nervous – like now.

Rob Carrick was kind enough to quote me in his Portfolio Strategy column of February 20:

A different take on the appeal of perpetual and fixed reset preferreds is offered by James Hymas, president of Hymas Investment Management. He doesn’t believe perpetuals will fall in price as much as some people expect and, regardless, he still sees some benefits in them for investors who want income.

His argument begins with the point that there are two issues to consider when choosing income-producing investments – the safety level of the investment itself and the reliability of the income it produces.

Fixed resets do a good job of protecting investors when inflation’s on the rise and pushing up interest rates, Mr. Hymas [pontificated]. But they fall behind perpetuals when it comes to preserving a reliable flow of income. Let’s say you bought some fixed reset preferreds back in early 2009, when they were being issued with yields of 6 per cent or more. Those shares could be very well be redeemed in a few years, leaving you in the tough position of trying to replace a 6-per-cent yield.

With perpetuals, your income flow lasts indefinitely, if not in perpetuity, and it’s comparatively safe.

“If you’ve got something from one of the big banks paying $1 a year, you can be as sure as you can be of anything in the investing world that you’re going to get that $1 a year until the shares are called,” Mr. Hymas said.

Mr. Carrick had to deal with the journalist’s constant bugbear: how to address a complex question for a wide swath of the investing public in 1,000 words or less. One question I must always ask when responding to queries on “interest rates” is: “Which interest rates?”. Short term rates are different from long term rates; government rates are different from corporate rates. And that’s just where we start!

The article has eight comments so far – a good one that addresses the issue is:

The premise of the article is that inflation is rising. Without that assumption all of it become irrelevant.

But there is no argument presented to support that premise. Just because very-short-term-government-set rates are rising does NOT mean that inflation is rising.

And just because the current month’s CPI was closing on 2% does not mean the rate is rising either. That rise is just a reversal of last year’s deflation – both short term events.

And, of course, even if we grant that FixedResets are good at protecting principal (which is only true up to a point – they are subject to exactly the same long-term credit risk as Straights) there is the eternal Fixed Income tug-of-war to consider between Protection of Principal and Protection of Income. You can’t have both; money market instruments emphasize protection of principal; straight perpetuals emphasize protection of income. FixedResets are in between – but not so close to the Money Market side of the struggle as many people like to think.

Update: A few more comments: the first, a retail view of the case for FixedResets (subsequent editing note applied to quote)

Rate-reset preferreds eliminate the risk of rising interest rates while perpeptuals expose you to full risk. If you bought bank reset perpetuals preferreds, when first issued in 2009, you now have a 10% capital gain (on paper )but most importantly a guaranteed 6% dividend over the next five years. If economic growth is slow then rates will not rise much over that time and the dividend is gold. The rate reset will then kick in to protect you going forward.

If rates do rise substantially, the banks will redeem the shares and you can re-invest in a high interest savings account until another investment opportunity presents itself. In this way your capital is preserved.

On the other hand, if you bought perpetuals and rates rise substantially, the shares will be deeply discounted and you will have a substantial capital loss. If you choose not to sell you will be locked in and have inferior returns going forward.

On a risk-return basis the rate-reset perpetuals preferreds are the winners IMHO.

The commenter got it right first time: rate-reset (or FixedReset, in my nomenclature) are indeed perpetuals, a thing that is very often forgetten in good times. The credit risk is forever. While the FixedReset structure does indeed provide protection against inflation (to the extent that this is reflected in 5-Year Government bonds, which is a pretty large extent!), but provides no protection whatsoever against credit risk. If a particular issuer gets into trouble between now and the next reset and is not able to refinance at a lower rate, it will probably not call the issue – and the price of the issue will, almost (but not quite) by definition be lower than par.

Additionally, one should always remember that in this wicked world, nice things cost money. Inflation protection is nice. And it costs money, as I have discussed in my essays on break-even rate shock. Naturally, having calculated the cost, one can quite legitimately take the view that it’s cheap at the price – but I suspect many purchasers do not attempt to quantify the cost in any way whatsoever. Especially when the same protection is available for free with Government real return bonds (RRBs)! I’m willing to bet that there are a few investors out there who have nominal Canadas and FixedReset preferreds, when it be more logical to own RRBs and Straight Perpetuals.

But the crux of the argument is If rates do rise substantially, the banks will redeem the shares and you can re-invest in a high interest savings account until another investment opportunity presents itself. In this way your capital is preserved..

Well, in the first place the banks’ decision whether or not to redeem the shares will have little, if anythng, to do with the rate on 5-Year Canadas. If those rates are high, then to a first approximation we may assume that all other rates will be high as well; and (also to a first approximation) the decision will be made dependent upon the cost of refinancing options. It is the Reset Spread that is critical to the refinancing decision, not the five year rate.

And in the second place, even a high interest savings account (paying what? 1%?) will not replace the lost income on call. You may have your principal but – as is too often the case with investors being far more concerned than they should be with Preservation of Capital at the expense of the other objective of Preservation of Income – income will suffer.

I rather liked one of the other comments:

James Hymas Rocks!

… even with the “thumbs down” comment rating!

A very nice piece by John Heinzl in today’s Globe: An Investor with a Preference for Preferreds.

Update: Finally got a heckler in the Globe’s comments section! An individual who was too ashamed to sign his name wrote:

There is a problem with the authors comment about firs loss protection. Pref Shares are equity from a balance sheet stand point, and the financial regulators treat them as such.

Pref Shares are equity investments with stated yield that must be paid before the common share dividend. THIS IS THE ONLY protection. It is not a bond, meaning the issuer does not have to make good on it to stay in business, nor do pref shareholders have any stake in the event of an insolvent company.

For reference, Please read p. 58 of Benjamin Graham’s book The Outstanding Investor. Or have a read at this study of preferred shares. http://www.pallas-athena.ca/Income_Investing_Preferred_Shares.html

Firstly, I don’t understand the author’s problem with my statement regarding first-loss protection. I was not referring to the balance sheet treatment specified by accountants or the regulatory treatment specified by Basel II – I was referring to the investment characteristic of first-loss protection.

• 1 – How much money did CIBC lose in 2008-2009?
• 2 – How much of this loss was borne by common shareholders?
• 3 – How much of this loss was borne by preferred shareholders?
• 4 – What conclusions may be drawn regarding first loss protection?

I am not aware of any book authored by Benjamin Graham titled The Outstanding Investor and neither is Wikipedia. The commentator may possibly be referring to The Intelligent Investor; I commented on an extract from this book dealing with preferred shares in my early 2009 post, Benjamin Graham et al. on Preferred Stocks. Briefly, Mr. Graham was writing in another time, under a very different tax regime; I agree that under the conditions described, it would be highly unusual for an individual investor to find an attractively priced preferred share – but those conditions no longer apply.

The essay published on the Pallas Athena Investment Counsel website, titled Preferred Shares: A Tutorial again references page 58 of the mysterious book The Outstanding Investor and quotes an extract from it that appears to be a verbatim copy of part of the passage from The Intelligent Investor discussed briefly above.

To be brutally frank, I do not consider the Pallas Athena analysis to be worthy of much detailed comment. Their first example assumes:

the dividend increases by only 27% over the next 4 years to $2.54.
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Therefore, $2.54 / 4% = $63.50. This is the price that the common shares should be worth at a 4% yield if the Royal Bank dividend on common shares will be $2.54 in 2013. A 27% dividend increase over the next four years is a very likely scenario; especially when we look at the past.

Given these assumptions, why would one ever invest in anything but Royal Bank common?

PA’s second example differs only in the starting price for the common.

This assumption is repeated in the third example. The preferred share used in the example is RY.PR.W at its lowest price, but the authors display their lack of familiarity with the preferred share market with the statement:

We will assume that we the shares are held until the end 2013, a few months prior to the scheduled $25.00 redemption in February 2014. For this reason, we’ll assume that the value of the Series W shares will be $25.00 at the end of 2013.

There is no “scheduled $25.00 redemption in February 2014”. That is when the shares become callable at par, which implies only a ceiling to the potential price, not a floor. This is, of course, favourable to the preferred share, but is inexcusable anyway. Naturally, the authors make the same assumptions about the future common as they do in the other examples (only the purchase price is different), leaving one to wonder yet again: why would anybody ever invest in anything but RY common if these assumptions are to be regarded as solid?

The authors conclude, in part:

The reality is that preferred shares are a tool for companies to increase their profits which is to the benefit of common shareholders or it is a tool for companies to solidify their balance sheet which is to the benefit of the lenders and bond holders.

Certainly, that’s as good a one-sentence explanation of the existence of preferred shares as any, but the authors neglect to inqure as to what price the company is prepared to pay for these benefits.

Preferred shares form a region on the continuum between debt and equity that will be attractive to many. That’s about the only general statement I can make!

I was not able to find composite performance numbers for Pallas-Athena Investment Counsel; if anybody has more luck, please let me know!