Why preferred shares plunged …

John Heinzl was kind enough to mention me in his Investor Clinic column today titled Why preferred shares plunged, and the ACBs of the Loblaw deal:

James Hymas, who manages a preferred share fund and writes the PrefLetter, said the recent drop may have been exacerbated by tax-loss selling, in which investors dump losing stocks in order to offset capital gains on their winners.

“There’s also a certain amount of ‘fighting the last war’ syndrome,” Mr. Hymas said in an e-mail. “People remember what happened the last couple of times the Bank of Canada cut its [benchmark] rate (January 2015, especially) and are terrified it will happen again.”

Despite those fears, after the recent drop many preferred shares now offer even more attractive yields. That’s especially true considering that preferred shares, unlike corporate bonds, qualify for the dividend tax credit. What’s more, assuming the five-year Canada yield stays roughly where it is, most preferreds will actually raise their dividends – not lower them – on the next reset date, Mr. Hymas said.

“My advice to current holders of preferreds remains the same as it was during the credit crunch: Shut up and clip your coupons,” he said.

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One Response to “Why preferred shares plunged …”

  1. jiHymas says:
    November 25, 2018 at 5:59 pm

    Comments on the G&M website indicated a certain amount of perplexity regarding the reference to retail investors:

    What is meant by the reference to dominance of this market by retail investors? What is the implication?

    … so I responded (in a three-part comment):

    A retail investor is an ordinary mom ‘n’ pop investor who manages his own account; or almost anybody who is advised by an ordinary retail stockbroker; or, sadly, a large number of those who have their portfolio professionally managed by an actual buy-side professional. Institutions such as mutual funds might have excellent management but are at the mercy of client cash-flows.

    The Canadian preferred share market is dominated by retail investors, as opposed to the bond market, which is dominated by institutional accounts. This is because of the tax advantage of dividend income – it’s of no use to non-taxable pension funds, foundations and charities, etc., so there’s no incentive for them to place their money in the market. Additionally, the low liquidity of the preferred share market both causes and is caused by high retail participation; executing a trade worth $1-million of any given issue, which is routine in the corporate bond market and trivial in government bonds, can be problematic and market-moving.

    The implications are that the preferred share market is both thin and volatile. Not only does the market move substantially on very little news, but it does so with very little regard for relationships with other markets; and when the market becomes unfashionable very substantial price movement can occur.

    For instance, one indicator I watch very closely is the “Seniority Spread” – the difference between the interest-equivalent yield on a Straight Perpetual trading below par and the yield on long-term corporate bonds. This spread has always been far higher than can be justified by default or duration risk; the excess is due to “liquidity”, that mysterious bat’s blood factor that plugs all the gaps. Currently, this spread is higher than it has ever been except for a very few weeks during the Credit Crunch and I don’t really see any rational reason for this.

    If this happened in an institutional market, you’d get contrarians piling into the market like crazy, hedge funds levering up as far as they could (margin and shorting rules make this problematic, of course, as does the lack of futures contracts – more “liquidity” issues!) and talking heads on business news shows talking up the asset class as if they were getting paid to do it … oh, wait, they are!

    But in this little market, virtually the only stabilizing influence comes from the issuers. One can be well assured that they have very little interest in issuing Straight Perpetuals at the moment. On November 19, CIU issued $385-million of 30-year bonds yielding 3.95%. Why would they issue Straight Perpetuals yielding, I’d say, somewhere around 5.75% instead? Sometimes there’s a good reason to pay up to issue preferred shares … but at that kind of differential, before considering tax, I’d say their treasurer didn’t have to spend a lot of time pondering the matter.

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