I’m grateful to Rob Carrick for kindly quoting me in his piece Amid a long bear market for preferred shares come glimpses of why you might want them in your portfolio:
“Common share dividends can be cut quite easily,” said James Hymas, president of Hymas Investment Management Inc. and an authority on preferred shares. “Preferred share dividends can only be cut when the common share dividend goes to zero.”
…
The preferred share index was down more than 30 per cent from its pre-pandemic peak to its March 23 trough, but then bargain hunters stepped in. “There was a growing sense that the yields available were completely ridiculous,” Mr. Hymas said. “At the bottom, you had the bluest of the blue chip companies yielding 7 per cent on their dividends.”A quick refresher on falling share prices and dividends: When stocks fall in price, their dividend yield rises. Mr. Hymas said that six months ago, rate reset preferred yields were in the 5.5 to 5.75 per cent range.
…
Preferred share dividends are more secure than common share dividends, but defaults have happened in rare cases. Mr. Hymas said these defaults are rare because the total amount of preferred share dividends paid out by companies tends to be a comparatively small corporate expense. Also, a company is considered to be financially failing when it suspends preferred share dividends. “It is extremely difficult for a company to get financing once it has pulled that trigger.”There are two main types of preferred shares – rate resets and perpetuals, which pay a fixed dividend. Perpetuals typically behave more like bonds, rising in price when rates fall and losing ground when rates rise. However, Mr. Hymas said perpetuals have been lumped in with rate resets lately and have not done well, either.
…
Why consider rate reset preferreds at all, then? Mr. Hymas says their yields are attractive now and would remain so even if they undergo a dividend reset at today’s depressed rates. And, as we wait for the pandemic’s impact on the economy to hurt corporate profits, there’s the added level of security over common share dividends.The do-not-ignore caveat: Forget about preferred shares altogether if you want a secure investment that doesn’t change much in price. “Preferred shares are volatile beasts and you shouldn’t buy them for preservation of capital,” Mr. Hymas said. “They are all about preservation of income.”
It is a pity that the article uses Current Yield to illustrate the reward side of the case in favour of preferreds, instead of calculating the yield properly as with the yield calculator for Resets. This inaccuracy is particularly glaring with respect to BAM.PR.B, a Floater paying 70% of Canada Prime based on par, so (2.45% * 70%) * 25 = 1.715% * 25 = 0.42875 p.a. The article touts a Current Yield of 9.1% at a price of 7.64, implying a dividend rate of $0.69524 p.a., or 2.78% of par, implying Canada Prime of 3.97% …. this is consistent with the March dividend of $0.172813 … prime hit 3.95% in October 2018 and was reduced to 3.45% in early March 2020 and then to 2.95% in mid March 2020 and then to 2.45% in late March 2020. Some people are going to be awfully disappointed.
“Preferred shares are volatile beasts and you shouldn’t buy them for preservation of capital.” “Some people are going to be awfully disappointed.”
It is hard for me not to be negative. I am sure a lot of people are already diappointed with the preferred share market in general. I am included among these as I bought at higher market prices. I did not sell any in the latest down market and I continue to collect my dividends. But I also did not have the guts to buy any more at the market price lows. Using YTW is a way to compare different preferred shares. Assumptions are that interest rates will remain constant and that at some point the preferred shares will be worth the purchase price (or whatever price the analyst chooses). So I would say that there is an assumption that your capital will be preserved in the analysis. I will have to have patience while I wait for this to happen.
So I would say that there is an assumption that your capital will be preserved in the analysis.
In my essay Security of Income vs. Security of Principal, I introduce the following definitions:
I do not differentiate much between “preservation” and “security” with respect to these two definitions!
“Security of Principal refers to the ability of the investor to receive his capital back, in cash, on short notice.”
For investors “with the willingness and ability” to hold preferred shares into the long term, Security of Capital flips from a risk to a selling feature. I’d go further and argue that there are only two reasons for long term holders to care about market pricing: as signals to sell something mispriced too high and to buy something mispriced too cheap.
Any idea why BAM.PR.B is recommended? Because of the yield? Anyway I am troubled by BAM.PR.B and BAM.PR.C. Issued on 11/9/1984 and 6/30/1984 (see https://bam.brookfield.com/stock-and-distributions/preferred-shares ) for $25 they are good candidates for the oldest preferred share (not sure which is the oldest preferred share). They even look older since the had predecessors. Maybe James would know which is the oldest one. Almost 36 years later they are worth a little more than $7 with no chance of seeing the original investment back too soon. I am curious to see the how much dividend they have paid over the years and how would they compare against a bond or S&P/TSX (it could look like comparing oranges with apples) but have not found a way.
Also what is Canada prime? There is a link to another post but it looks like it is set up by each bank and it is influenced by BoC.
I do not want to argue with people smarter than me but I believe lots of fixed income investors would look at getting their principal back at some future maturity date as a reasonable feature of their investment. Many of these investors are also happy with time lines such as 5 years and I was not implying anything in my comments about short notice.
The actual headline for Rob Carrick’s Globe and Mail article is “For a fairly safe bet, consider preferred shares”. I wonder how that will be interpreted. The main discussion in the article is the high current yield offered by many securities with good credit ratings. In my opinion the headline is making a statement that since the market price today is low; an investor’s principal on a new investment is somehow underpinned.
My own investments are a mix of high interest savings accounts, GIC’s, preferred shares and common stocks and REITS. May be I am no longer cut out for the volitility of the market. I also did not take advantage of the opportunity presented with TXPR around 400. I felt I already had enough preferred shares.
“I am curious to see the how much dividend they have paid over the years”
Their website only shows dividends back to 2012. However, these issues came to life right at the beginning of the decades-long march to today’s low rates. Without having the data or doing much math, it seems fair to surmise that BAM.PR.B has distributed north of $36 (in 2006 it was paying $1.05 per year. This is just past halfway point between the issue date where prime was about 12% – so the issue probably paid more than $2 per year -and the last payment at a rate of $0.69 per year).
If prime stays at 2.45%, BAM.PR.B will pay about 43c for a yield of 5.9% at Friday’s close. So the original purchaser (who is 36 years older!) most certainly has had his/her original principal returned plus, and can continue to hold and enjoy a solid dividend at current low rates.
Also I should add to my previous post that the long term chart of BAM.PR.B doesn’t look anything like the long term chart for prime. It is currently trading near the all time lows during the financial crisis from which it bounced back to ~$18 a couple years later, a level at which it hovered for about 5 years before falling to ~$10 in early 2016, then climbing back to ~$18 in 2018, from which it fell to today’s lows.
Point being, there is no reason to recover only $7 and change from BAM.PR.B. Our 36 year older investor should just wait for in the inevitable re-flation to something much higher. In the insolvency betting pool, BAM gets pretty much zero bids.
The problem I believe is that we all got burned by “in perpetuity”…
There was no onus by the company to redeem the shares when investors wanted, but investors could be forced to sell back to the company.
So investors were at a disadvantage, and “perpetual investors” got burned into thinking it was secure.
I won’t by any more of these “perpetuals”. Unless the ability to redeem is two way!! Otherwise there is “no security of principle” !!!!!!
Point being, there is no reason to recover only $7 and change from BAM.PR.B
We should also consider that according with BoC inflation calculator $25 from 1984 would be today $57.35 today. If we consider 36$ distribution over the years you are still in red after 36 years later. No wonder why BAM.PR.B/C has not been redeemed and why preferred shares are considered a such good business for a company. If you are not carefully, knowledgeable, lucky, etc you have close to no chance against the system (companies and banks).
“We should also consider that according with BoC inflation calculator $25 from 1984 would be today $57.35 today”
Note that the income stream would also be inflated, so that $36 (which was a guesstimate) would be something much higher also. Still though, all-in-all if an investor bought in 1984, went to sleep, woke up this week, panicked and sold, it would not have been a great investment.
It’s interesting to compare the performance of any class of preferred shares with the common stock of the same issuer. It would be an interesting study.
For BAM, the common stock was $1.xx in early 1990s. Now it’s close to 50. So about 40 times higher, plus the dividends.
I think it’s entirely possible that ‘too good to be true’ preferreds would be called.
So it’s a rigged game against the preferreds for long term investing.
Why own preferreds over the long term?
IMHO, the only way to make money off preferreds so far has been to clip coupons and buy them when they are selling for way below their par price.
Anybody have data to prove otherwise?
For investors “with the willingness and ability” to hold preferred shares into the long term, Security of Capital flips from a risk to a selling feature.
Yes, at least in a way. The volatility keeps many people away, which increases the Liquidity Premium, as discussed in the post The Value of Liquidity and in my article Credit Spreads and Default Risk … and many other places, but those two references are a good place to start!
I’m only interested in preferred shares because they’re crazy. If they behaved rationally they would be boring and you wouldn’t be able to make nearly as much money on them. I hope they stay crazy for a long, long time.
“IMHO, the only way to make money off preferreds so far has been to clip coupons and buy them when they are selling for way below their par price.”
This is half of the best way to “make money off” them. The other half is to sell them when they are priced far too richly versus their peers (then buy those). Paraphrasing Rod above, the crazier the better or James, also above, volatility is our friend in this market.
Which means, the rules for preferred market are:
1. Buy and hold doesn’t work.
2. ETFs don’t work.
3. Active trading is the way to go.
4. Market timing is the key.
This is blasphemous talk for a majority of modern investors. Yet, it has worked beautifully for me over the last few years and I don’t see the trends changing anytime soon. But I’m ready to be surprised.
1.”Buy and hold doesn’t work”
Really? Surely that depends, broadly, on how long you hold. The longer you hold your perpetuals. for instance, the more your return becomes a readily identifiable function of distributions received, not the end price when you sell. Ditto, although with less precision, for resets.
2.”ETFs don’t work”
ETFs do have an influence on the market, not always positive in that they can accentuate volatility, but is there something inherently wrong with buying the market? Also, not all ETFs are alike. For instance, CPD has always had some perpetuals added to the mix and has outperformed its brethren.
3.”Active trading is the way to go”
Really? That assumes that you know more than most others on when to buy and sell, or you have some sophisticated algorithms that tell you when to buy and sell. Otherwise isn’t this “rule” just another version of market timing?
4.”Market timing is everything”
Only with hindsight! If anyone knew how to time the market, they wouldn’t be writing these posts but relaxin’ on a beach in a tax haven!
“[The above rules] … ha[ve] worked beautifully for me over the last few years.”
Really?
“3.”Active trading is the way to go”
Really? That assumes that you know more than most others on when to buy and sell, or you have some sophisticated algorithms that tell you when to buy and sell. Otherwise isn’t this “rule” just another version of market timing?”
With respect to preferred shares, mis-pricing is not a bug in the market, it is a feature. There are lots of reasons for it, most of which are discussed quite regularly on Prefblog and debated in the replies. Taking advantage of mis-pricing is not market timing, it is the fruit of ongoing analysis, monitoring and readiness to act.
100% agree!
I stumbled on to this blog whilst searching for info on DGS.to Dividend Growth Split Corp. Class A with Brompton. I’ve scoured the prospectus, but can’t quite understand the concept (or strategy) of the quarterly retraction of shares. Under what circumstance would a pref shareholder want to exercise this retraction?
Under what circumstance would a pref shareholder want to exercise this retraction?
The formula for the DGS.PR.A monthly retraction in my notation is 96%NAV – C; that is, the retraction price is 96% of the NAV less the cost to the company of purchasing a Capital Unit match (an upper limit of $10.00 is understood).
This is rarely a profitable exercise, but my fund, MAPF was able to retract 10,000 WFS.PR.A during the Credit Crunch, which was very profitable and extremely satisfying.
However, the opportunity soon became widely known and so the monthly retraction price quickly became a floor for the preferreds, with potential profits from retraction (relative to the market price) becoming either non-existent or so small that the potential was outweighed by the uncertainty inherent in having to tender the shares two weeks in advance.
On April 9, for instance, I calculated (as part of my groundwork for PrefLetter) the following figures for the DGS.PR.A monthly retraction:
Whole Unit NAV : 12.79 (as of April 8)
Adjustment: 0 (there wasn’t much move in the underlying portfolio from the 8th to the 9th)
Preferred Bid Price: 9.15
Capital Unit Ask Price: 3.41
Estimated Retraction Price: 96%NAV – C = 0.96*12.79 – 3.41 = 8.87
Estimated Profitability: -3.08%.
Like many other Split Share Preferreds on that date, it was trading ‘in the neighborhood of’ its Monthly Retraction Price, so there wasn’t really any incentive to retract – particularly given the inherent uncertainty mentioned above.
This is not to say the feature is useless, however!
Consider WFS.PR.A: this also has a monthly retraction feature, but the retraction price is dependent on the market price; it’s designed to be useless. This is a point (among others) against buying WFS.PR.A as an investment, since we can’t rely on a decent pricing floor during bad times.
One other thing … it was most interesting to see how well the Capital Units retained market value in the face of rapidly declining intrinsic value during the depths of the crash. I got an angry eMail from an investor who was outraged that this made his retraction feature useless … the tendency caused a lot of retraction features to be useless. Perhaps what’s needed is a few more months of panic-stricken equity declines, to squeeze the excess pricing out of the Capital Units and so increase the preferreds’ retraction prices.
James, much appreciated. Wish I had found this treasure sooner!!
Your thoughts on OSP (Brompton Oil Split)? I’m trying to understand their recent pro-rata redemption of class a shares…is this rare with stock splits funds or would this also occur with DGS?
If you go to the home page of the blog (which you can reach from anywhere in the blog by clicking the big “PrefBlog” in the title), you will see a search box at the top of the right-hand navigation panel.
Type OSP.PR.A into the search box, click “Search” and you’ll get a list of all the posts that contain the string “OSP.PR.A”; posts with the string in the title will be listed first; click on the title of the post to read the post.
Hope that helps!
Two things…
Be careful with OSP… Their assets are down to $5m. Weird stuff happens with small funds.
For some split funds, if you hold both the CapitalShare and Preferred, they can be redeemed for cash. On days of massive market volatility, the pair can some time be bought for less than the underlying asset.
During normal times the “combined Capital and Preferred” is normally priced at a premium to underlying assets. One way to play it is if your going to buy the underlying shares anyways as long term hold, buy the splits and maybe you’ll get the premium down the road as well (subject to their admin fee).
A long while back I had a conversation once with one of these split fund managers about redeeming just the one type of share. He mentioned that sometimes they will redeem just the one if there is a mismatch.
Unfortunately I no longer have this email.
James, have you had any discussions like that with any manager ? Of course, with the “preferreds” trading at a huge discount to NAV, why would they give you NAV when they can buy it on the open market for less.
It’s hard to understand why there are so many sellers in some of these pref splits. FTN and FFN for instance have had large displayed and reserve sellers in the 8.70 range for a couple weeks now. One person displayed and traded 174,000 shares in a single order! With the NAV of the total unit 12+ I have trouble comprehending it.
I redeemed my Oil Split prefs but the amount I received is puzzling. The last 4 posted asset values pre redemption were 4.57, 4.12, 4.21 and 4.77, an average then over the last three days of 4.333. The AIF contains a brief, cryptic reference to redemption being based on weighted average values over the last three business days, not quite consistent with my calculation. Nevertheless, my calculation should be a reasonable expectation of the proceeds. On April 15 I received 4.188 per share and a 12.5 cent dividend for a total of 4.313 – close to my expectation – but then the 12.5 cent dividend was reversed. So, I’m left with 4.188 which seems like an improbable result given the posted values. Brompton has so far not responded to my request for an explanation.
EL Preferreds represented the largest part of my portfolio for many years. I wasn’t interested in resets because of the added risk of interest rates going down. I was interested in the security as EL has a stock portfolio as a holding company that covers the preferreds 10 times over so even if my operating company Empire Life went to zero I am fully covered. So I looked at it a risk free asset and still do. According to The Intelligent Investor you should only invest in riskier assets when they pay you double what you can get holding a risk free asset. So I am looking for commons with a P/E of 6.5 or less with sustainable earnings. Tough to do. After selling my EL preferreds back to the CEO of the company as the public market is too illiquid, I am buying the back a bit again. A 7.8% interest equivalent yield in a risk free asset is hard to pass up. And in my younger years I had 100% of my RRSP in a steel maker IvaCo senior preferreds which were retractable in 1 year at double the trading value so yes preferreds should always be part of one’s portfolio. Term deposits never.
Re the redemption of Oil Split prefs mentioned by JSS, I am also bewildered by the calculation.
In announcing the extension on Jan. 30, the company said any pref redemptions would be handled according to the prospectus.
The prospectus says:
“All Preferred Shares outstanding on the Maturity Date will be redeemed by the Company on such date. The redemption price payable by the Company for a Preferred Share on that date will be equal to the lesser of (i) $10.00 plus any accrued and unpaid distributions thereon and (ii) the NAV of the Company on that date divided by the total number of Preferred Shares then outstanding.”
Chad Pether, Manager, Product Development & Marketing | Brompton Funds, responded to my email inquiry by saying this:
“The redemption price is calculated differently than the posted NAV on March 31. For a retraction or redemption of the Company’s shares, the portfolio securities are valued based on the weighted average trading price of such shares over the last three business days of the relevant month, whereas the posted NAV is based on the closing prices of the securities on March 31. The posted NAV also reflects the post-redemption number of shares. Since a substantial portion of the Fund’s assets were comprised of cash to fund the redemption and as a result of the weighted-average price calculation, the redemption NAV ended up being lower than the NAV per post-redemption share.”
I don’t understand why the prospectus calculation was not followed. Pref holders appear to have been disadvantaged. I have asked for further explanation.
I am hopeful James and other affected holders might be able to explain what happened, or help take up the cause.
You are absolutely correct that it appears that the prospectus was not followed, but you were obtaining the “Month end price as posted on the web site” to be the NAV of the fund at month end. That is not exactly the same thing, but I would tend to think that it should be pretty darn close.
In essence it should be the same, but maybe due to the huge amount that was in cash and the huge amount redeemed, the numbers were slightly different. Maybe asking what the March 31st value was (or even the numbers for each day) may help to explain the perceived dependency.
By the way, record what is on the website for future reference.
I’m glad someone was able to get a response from Brompton.
The disclosure in the prospectus and other documents about what happens on an Oil Split retraction is cryptic and contradictory. The lack of transparency about the retraction since March 31 is also unhelpful.
The explanation about the effect of having cash on hand doesn’t make sense to me. Having cash doesn’t affect the value of other assets. If they created two pools of assets – one for retracting unitholders and one for those staying in – that’s inconsistent with their disclosure.