I’m way late reporting this, but I only just realized I hadn’t added it to my press clippings file!
Scott Blythe was kind enough to quote me in his advisor.ca Special Report No shortage of risk in preferred shares:
“One thing to consider is who benefits from new issuance. There was a big spike in spring 2009 when all of the banks were busily raising capital hand over fist,” notes James Hymas, who blogs on preferred shares and runs the Malachite Aggressive Preferred Share Fund. “We’re certainly not back to those levels yet, but on the whole the preferred share market has grown considerably over the last 10 years. There are a lot of new issuers coming out and some of the old issuers are starting to put their toes back into the water.”
Because of their place in the credit structure behind bondholders, investors could be wiped out. Hymas notes two major issues that have defaulted: Nortel and Quebecor World.
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Hymas estimates that preferreds trade at a yield of 195 basis points over equivalent corporate debt. Of that, 10 basis points can be attributed to credit risk. The rest is a liquidity premium.“Liquidity is extremely important in the preferred share market; you can make excess returns by selling liquidity and you can get make horrible returns by buying it.”
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“It depends a lot on the time scale that you want to look at,” says Hymas. “On a day-to-day basis, individual issues can vary considerably and also on a day-to-day basis the market as a whole can do very extreme things for various reasons. However over the long run, the market is only a little bit more volatile than long corporate bonds.”
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“There are two major components to the prices: the credit risk and the interest rate risk,” Hymas explains. “The fixed resets and the floaters address the interest-rate part of the equation but they do not address the credit risk part of the equation. So a lot of people tend to buy fixed resets, for instance, on the grounds that they are just five year issues, but that is not correct. The interest rate risk might be about five years, but the credit risk is forever.”On credit risk, PFD1 indicates stability as good as a bank; PFD 2 ratings are equivalent to an investment grade corporate bond, while PFD 3 is more like a good high-yield bond.
That said, Hymas advises against buying solely on yield.
“A lot of people attempt to build fixed income portfolios from the bottom-up, which is a horrible mistake. A fixed income portfolio should always be built from the top down, meaning that you first understand what the client is attempting to accomplish with his portfolio and then pick pieces out of the jigsaw puzzle that fit. It’s simply a question of keeping in mind what the client is attempting to do.
“Simply ‘making money’ is not an investment plan, though there are many advisors who will tell you different.”