Brompton Funds Limited has announced:
that at special meetings of preferred and class A shareholders (“Shareholders”) of Dividend Growth Split Corp. (“DGS”) and Brompton Split Banc Corp. (“SBC”) held today, Shareholders approved special resolutions to implement amendments to update and modernize the investment objectives, investment strategies and investment restrictions of DGS and SBC as well as certain other matters set out in the joint management information circular dated July 27, 2018 (the “Circular”).
For DGS, the changes to the investment objectives, strategy and restrictions are primarily designed to accomplish the following:
i) expand the investable universe of high quality dividend growth companies from which the portfolio manager can select by expanding the financial metrics that may be used to analyze the portfolio constituents, including forward-looking metrics;
ii) provide for up to 20% of the portfolio to be invested, from time to time, in global dividend growth companies; and
iii) allow the Manager to rebalance and/or reconstitute the portfolio more frequently than annually, at its discretion, for reasons other than the suspension of dividends, mergers or fundamental corporate actions or exceptional circumstances, so that DGS may respond to security or market developments on a timely basis.
…
Further information relating to these and other changes are described in more detail in the Circular. These changes are expected to be implemented as soon as reasonably possible.
I do not view this loosening of restrictions as being material.
The changes described in the covering letter seemed pretty innocuous. However, upon reading through the details of the info circular, I found a couple of significant changes that were not mentioned in the covering letter:
i) Preferred shares will no longer have a specific distribution amount (currently set at $0.13125 per quarter),
ii) Preferred shares will be redeemable at the option of management on a pro-rata basis on the Special Retraction date, in order to maintain the same number of Class A and Preferred shares.
I bought DGS.pr.a. because of the fixed distribution, and because the shares were not redeemable at management’s option. So these changes are significant to me. I’m wondering how to compare DGS.pr.a to other split preferreds. Should YTW calculations assume a portion of the shares will be retracted on the annual retraction date? Also I’m not sure what to assume for the future distribution since there is no longer a specified distribution. What are your thoughts on these proposed changes?
The info circular described similar changes for Brompton Split Banc preferreds. I expect that Brompton will eventually make similar changes to all of their other split preferreds, so I am considering selling all of my Brompton split preferred holdings.
I had the same concerns and voted against the resolution. I was being asked to give up something and was getting nothing in return. I did question their investor relations about this and got this answer:
“At the end of the current term, and for future new terms, the Board will go through a process of surveying comparable pref shares. The fund will announce a new rate, based on then-market rates at that future time, at least 60 days before the start of a new term.
It may be that comparable prefs are yielding more or less at the time of a future reset, so it make little sense to continue an investment objective for the fund that states a fixed amount (5.25%) given that in the future the pref dividend may be more or less based on market yields at that time. Clients will always be able to decide whether they like the new rate for the new term (in which case they can continue to hold the pref), or whether they don’t (in which case they can either sell the pref on the TSX or they can redeem their holdings)”
I believe these concerns are misplaced. Taking them out of order:
Preferred shares will be redeemable at the option of management on a pro-rata basis on the Special Retraction date, in order to maintain the same number of Class A and Preferred shares.
OK, so what is a Special Retraction Date? It’s defined in the Information Circular:
So it’s applicable only at the end of every term. From the 2017 Annual Information Form:
So here’s what’s happened: when Split Shares were invented, the company was supposed to exist for (usually) five years, then liquidate.
However, with the disappearance of Operating Retractibles, it soon became no problem at all to sell the preferreds and – such is the state of the market – the Capital Units didn’t change in difficulty to sell … if the market was going up, it was easy, if down, hard.
So they came up with the idea of extending term. This can be done with a shareholder vote. Some companies redeemed their preferred shares in order to avoid giving them a vote (see ABK.PR.C Redemption to be Funded by New Issue (2008), ABK.PR.B To Be Refunded On Reorganization (2013) and ABK.PR.C To Mature on Schedule (2018; confusingly, they recycled the ticker symbol at the 2013 refunding)), while others offered a term extension and change of dividend in order to coax out a favourable vote (see DGS.PR.A Extends Term, Proposes Treasury Offering and DGS.PR.A Resets To 5.25%, Unchanged).
One way or another, the dividend rate for the extended term has to be pretty good, because – critically – the preferred shareholders have the ability to retract. This is unlike FixedResets, for instance, which would have been retracted in mass quantities during the bear market if the holders had had that power.
The fact that it is now possible for preferred shareholders to accept the new terms and then have part of their holdings called away is annoying – it will leave a lot of people with mixed-lots – but the basic structure of the investment still applies: you will receive a fixed rate until a fixed time. At that time, you have the ability to retract at par (or at the NAV, if that is lower). Or, if the terms of the extension are sufficiently sweet, you can keep your shares and go along for the ride.
i) Preferred shares will no longer have a specific distribution amount (currently set at $0.13125 per quarter),
There was never any guarantee that a refunding issue would have the same or greater distribution rate.
You should continue to look at these things as you (presumably) always have: they’re a five-year (or whatever) investment. At the end of those five years you’ll get the par value back in cash (unless something horrible has happened in the market) and you can then reinvest that in whatever you like. Sometimes you may reinvest in the same issue with new terms.
With the notion of extension being introduced, it is interesting to note that the interest of the fund manager (i.e. Maintaining a revenue flow) and of the capital holders are no longer aligned. At redemption, I would argue that it is in the interest of the fund manager to offer a good and maybe above market dividend in order to minimize redemption which will erode future capital gains on the capital shares. Given that a lot of those trade at value above NAV, I cannot see the long term value in those.
On another note dividends on the pref in split shares can sometimes fluctuate for the better as it did for ftn.pr.a moving from 5.25% to 5.5% a while ago. To this day, I still do not understand why the fund manager did it but as an owner of those prefs I do not complain….