Rob Carrick was kind enough to quote me in his piece A close-up look at preferred share ETFs, a mega-hit with investors turned surprise money-loser:
The people selling preferred shares and the ETFs that hold them include investors who used rate reset preferreds as a way to profit from rising interest rates, said James Hymas, a preferred-share specialist who manages the Malachite Aggressive Preferred Fund for high-net-worth investors.
“The other class of sellers are people who are selling just because these shares are going down,” Mr. Hymas said. “They’ve take pretty significant losses in the last eight months or so and they’re saying, ‘I’m out.’”
Mr. Hymas’s guideline for investing in preferred shares is that you should only use money you’re pretty sure you’re not going to need for 10 years or more. That way, you can ride through the periods of volatility that seem to be inevitable in a world where interest rates keep defying expectations. Pref shares are particularly attractive in non-registered accounts, where the dividend tax credit applies.
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Bond yields could definitely fall further, so there’s a risk that the yield from rate reset preferreds might be lower still. But Mr. Hymas points out that there’s nothing exceptional about holding income-producing investments that renew at lower yields.This happens all the time when investors use five-year ladders of guaranteed investment certificates. That’s where you invest equal amounts in GICs with terms of one through five years and then invest maturing GICs back into a new five-year term. Anyone who has done this in recent years knows that it’s common to renew at lower rates.
It’s also important to understand that the problems faced by preferred share ETFs have nothing to do with the quality of the securities they hold. While Mr. Hymas points out that some less financially solid companies have entered the preferred share market in the past 10 years or so, most issuers are big banks and other blue chips that can be relied on to pay their dividends.
Preferred share ETFs are a hostage to interest rates, then. The rate reset shares they mostly or exclusively hold are pummelled when rates fall and they’ll have their day when rates rise. “As a matter of fact, I think they’re going to shine even if things stay the way they are now,” Mr. Hymas said. “I believe they’re totally oversold at this point.”
But Mr. Hymas points out that there’s nothing exceptional about holding income-producing investments that renew at lower yields.
James is making the argument that the market price rate reset preferred shares (RRPS) do not need to drastically fall when the RRPS dividend resets lower just as a 5 year GIC in a GIC ladder may be renewed at a lower interest rate with the same principle amount as was invested 5 years before.
However, Rob Carrick makes the general theme of the article to be that the market price of RRPS fall when interest rates fall and rise when interest rates rise.
I doubt my hope is for more market price stability for RRPS in different interest environments is going to be met by this article. Rob Carrick is just reporting that what has happened in the past will happen again.
I’m trying to determine whether to incorporate a preferred share ETF into my investment holdings, and wanted to check my assumptions … If I am correct, from this blog and from the globe and mail article wherein James was quoted, both CPD and ZPR are very oversold/undervalued. Is there a metric or mechanism to determine ZPR value at a point in time (based on current BOC 5 year rate and rate reset assumptions)? Also, the investment value of ZPR is in it’s reset ladder and diversification, and it’s a downside is a .5% MER. And rather than using an ETF like ZPR one could select a basket of rate resets that would not have that MER and would potentially be better credit risks and/or higher yields, depending on one’s own preferences. And the challenge then is in selecting which rate resets. From my view as a novice getting access to clear data on resets is very challenging. TD discount brokerage has scant information available when looking at preferred shares.
Pref shares are particularly attractive in non-registered accounts, where the dividend tax credit applies.
True. But since withdraws from TFSAs are are not taxed, there can be marginal tax benefits given ones marginal tax rate. And it may be even more important in the years when one is 65-71 years old. Not an expert here by any means.
fft.