PrefBlog

AS I state in the introduction:

In last year’s review of Canadian preferred share funds, I discussed the explosion in the number of decision-makers in the investment market-place; the decline in Defined Benefit pension plans and corresponding increase in Defined Contribution plans and other forms of saving have changed the investment world from one in which the decisions were made by a relatively small group of specialists to a world in which investment management is just another consumer good. This change has resulted in an explosion of consumer choice and a consequent rise in the importance of marketing to the success of any investment product, as opposed to old-fashioned concepts such as risk and return.

In this essay I will discuss

• • the manner in which investment decisions – particularly with respect to index funds – are made
• • the use of derivatives by index funds
• • the explosion in the number of indices in recent years, as the notion of passive investing has become more fashionable

The 2010 comparison is available via THIS LINK.

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A brief review of different types of yield calculation.

Part 2 of this discussion is available via THIS LINK.

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CIBC was able to change the status of some of its preferred shares from DeemedRetractible to NVCC without a shareholder vote in 2011. This short essay looked at the implications of this move for other issues.

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As I state in the introduction to this essay:

Dividend Capture is an investment strategy that is based on the idea that market inefficiencies and differential taxation of capital gains and dividends can be exploited to produce excess returns by owning a security for a short period of time that includes the ex-Dividend date. One recommended strategy is to “Buy the stock the day before it goes X, capture the dividend, and sell it the next day. This is the most common Dividend Capture strategy, and the subject of the most academic research (Campbell and Beranck 1955, Durand and May 1960, etc). While the market is rising, this is the simplest, most efficient and least volatile way to capture dividends.”

I discuss various examples of Dividend Capture and examine the usefulness of the concept in the Canadian preferred share market.

This essay also continues the mathematical work embodied in the June 2010 Prefletter essay “Closed Form Yield Calculation”, using the Exponential Approximation as a simplifying tool.

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Update 2023-3-28: I hadn’t been aware of the following wrinkle, brought to my attention by the 2023 Federal Budget : Tax Measures : Supplementary Information:

The Income Tax Act permits corporations to claim a deduction in respect of dividends received on shares of other corporations resident in Canada. These dividends are effectively excluded from income. The dividend received deduction is intended to limit the imposition of multiple levels of corporate taxation.

The mark-to-market rules in the Income Tax Act recognize the unique nature of certain property (“mark-to-market property”) held by financial institutions in the ordinary course of their business. Under these rules, gains on the disposition of mark-to-market property are included in ordinary income, not capital gains, and unrealized gains are included in computing income annually (in addition to when the property is disposed of). Shares are generally mark-to-market property when a financial institution has less than ten per cent of the votes or value of the corporation that issued the shares (“portfolio shares”).

The policy behind the dividend received deduction conflicts with the policy behind the mark-to-market rules. Although the mark-to-market rules essentially classify gains on portfolio shares as business income, dividends received on those shares remain eligible for the dividend received deduction and are excluded from income. The tax treatment of dividends received by financial institutions on portfolio shares held in the ordinary course of their business is inconsistent with the tax treatment of gains on those shares under the mark-to-market rules.

To align the treatment of dividends and gains on portfolio shares under the mark-to-market rules, Budget 2023 proposes to deny the dividend received deduction in respect of dividends received by financial institutions on shares that are mark-to-market property.

This measure would apply to dividends received after 2023.

It seems that Dividend Capture has been very profitable for trading desks! The revenue impact of this change is estimated at about $800-million per year.

This essay extends the prior discussion of annuities presented in Annuities Part 1 and The Annuity Decision.

A retirement calculator is provided and discussed, with notes on its design, shortcomings and potential for future enhancements.

I conclude in part:

My advice is to remain as flexible as possible. Retirement plans should be updated annually, while eschewing the temptation to over-manage one’s assets. Investors should focus on a 15-year plan (at the most) rather than a 30-year plan, while keeping a sharp eye not on the prospects for ruin, but for the prospects of large cuts in final results.

If, for instance, the first 15 years of retirement investment go badly, there is no need to continue with the same allocation for the next 15; and this should be recognized at year zero. In year 15 an annuity will be a lot cheaper than it is at year zero, and risk should be assessed with this in mind. In many cases, I suggest, an annuity purchase should be deferred, using the potential for annuity purchase as a safety net for one’s retirement planning. After all, they grow a bit cheaper every day of your life! They also represent an irreversible decision – so plan to drop off your cheque on your way home from the doctor’s office, not on the way there!

Cash is important. If at all possible, withdrawals from the portfolio should be funded by portfolio income; if there is a shortfall, consider shifting to higher yielding assets (without assuming too much risk, of course! It should be recognized that a higher cash yield will result in a lower expected capital gain). If that still does not solve the problem, an annuity should be considered.

And, by all means, don’t take this or any other financial projection too seriously. They are useful as background, to allow you to play with the effects of different decisions, but they all rely on highly uncertain predictions of future events. Remember: I didn’t predict a wave of revolts across the Middle East this year – and neither did anybody else.

Look for the research link!