The reissue of BCE.PR.K in December, 2011, was one of the most cynical or most ignorant moves by preferred share underwriters and salesmen I have ever seen. So I was prompted to, yet again, implore investors to look at valuation factors more important than Current Yield.
As I state in the conclusion:
Issue Reset Spreads are extremely important in the valuation of FixedReset issues that are not expected to be called – as a rough rule of thumb, I suggest that this includes investment grade issues with an Issue Reset Spread of 200bp or less, and junk issues with an Issue Reset Spread of 300bp or less. I consider the situation for issues with Issue Reset Spreads up to 100bp greater than these thresholds to be unclear, and will depend on relatively minor changes in market conditions.
Investors should pay particular attention to the Issue Reset Spread when selecting issues – even if one does not wish to perform a precise yield analysis for a presumed level of the GOC-5 rate, one should at the very least calculate what the Current Yield will be if the current price is maintained after reset at some reasonable and consistent value of GOC-5.
Look for the research link!
Hi,
I would never have thought I would see the destruction we are seeing in the preferred market. I keep buying more and they keep going down. Maybe if I stop buying they will bounce back 🙂 Unbelievable carnage throughout the equity market. Starting to feel that the end of the carnage is near with the US 10 year trading at 2.8%. Expecting my recent purchases to pay off in the next 2 years or so.
FerrisWheel
yes. it was carnage .. complete destruction… all prefs stopped paying dividends. they all dropped to zero.
no. wait that didn’t happen.
have you ever looked at a chart of your preferred shares? going back as far as possible? you DO realize, these are not GICs? do DO realize they go up and down depending on market conditions and interest rates?
if you want an investment that doesn’t move, buy a locked in GIC for 5 years. then it’s smooth sailing.
FerrisWheel I think you will do fine. It is not often that the yield curve inverts so lower yields are likely on the way. I started investing in term certificates many years ago with an annual pay out to provide me income during my dry months. I wish I knew about preferred shares then. I recently asked my son who is also “in the investment business” about how much you can earn in straight dividend income without paying income taxes and he had never been asked the question before. I think it’s about $60,000? Or for younger investors putting deposits in the Royal Bank. Why not just buy their preferred shares instead? A great “tool” to learn about tax preferential income, the “pain” of seeing your investments fall in price, the ability to ignore all the “noise” disguised as news pulling on you to buy or sell. Buying based on faith in your knowledge and experience not greed. Preferred shares should form the base for all Canadian investors.
dan good , now is a great time for the young investors to start building their div income , but it doesnt only have to be with the preferred shares lots of over 6% common . and if you want common have options , i am selling cash covered naked puts on the banks , its a great way to buy the stock cheaper or if you dont get filled generate revenue . just make sure they are cash covered .
if you want an investment that doesn’t move, buy a locked in GIC for 5 years. then it’s smooth sailing.
I must admit that I become unreasonably exasperated whenever I hear this old chestnut.
Let us say Jane buys a 5-year, semi-annual pay GIC to yield 3.25% (within her CIDC limits) and Joe buys a 3.25% five-year GOC bond on the same day, which is a coupon date.
Same guarantee. Same maturity. Same cash flows. Only difference is that the GOC can be traded and the GIC can’t.
Now yields suddenly spike to around 4.25% and the bond price is reported as around 95.00, while the GIC continues to be quoted at 100.00. “Hurray!” says Jane. “I’m the better investor!”. “Hurray!” say the regulators. “Wonderful reporting is helping another retail client! Maybe now I can get a new job!” “Hurray!” says the bank’s marketting department. “We’ve conned another sucker into thinking GICs are safer than bonds!” “Hurray!” says the bank’s Department of Regulatory Affairs. “We need another compliance employee who is a team player with regulatory experience! Can we offer you a fat salary?”
Why are banks permitted to report GIC values at historical cost? It’s misleading. It is, in fact, a lie.
why ? you ask , you answered your question ,when you wrote ..” Only difference is that the GOC can be traded and the GIC can’t”….. i agree with that, because there is no market for a bank gic , so if rates go up the gic holder can not sell at the 95.00 and if the rates go down the gic holder can not sell at 105.00 . there is no market price if it can not be sold . what would the point be to quote the gic at anything other than 100 ?
what would the point be to quote the gic at anything other than 100 ?
Comparison to indices and other accounts (including the performance reporting required by the CRM rules). In addition, with the CRM rules the regulators purport to be very interested in ensuring that unrealized losses and gains be accurately reported to the account holder. With historical price reporting, that information is being withheld.
Somebody who buys a 3.25% instrument only to find himself in a 4.25% environment the next day is suffering just as much as anybody else, regardless of what pricing is used.
i agree with that, because there is no market for a bank gic , so if rates go up the gic holder can not sell at the 95.00 and if the rates go down the gic holder can not sell at 105.00 .
So if I buy a 5-year GOC and sign a contract in blood stating that I will hold it to maturity, can I get historical cost reporting for my investment too?
I will also point out that this fiction of constant value gives the banks a marketting advantage over other investments, which does not reflect reality and hence is contrary to the public interest.
i know James, i agree completely. but if someone is totally freaked out about swings in their prefs, maybe a GIC is for them. reality be damned.
” So if I buy a 5-year GOC and sign a contract in blood stating that I will hold it to maturity, can I get historical cost reporting for my investment too?” james i think you meant gic . the people that i talk with (and try to talk out of buying gic instruments) , tell me oh no i cant stand any loss . i think they are very happy that the gic does not ever show less than 100.00. as far as the “fiction of constant value” not reflecting reality , with out a market i think that is the real value and the people that buy them are happy with that and buy them because of that . as far as ,” only to find himself in a 4.25% environment the next day is suffering just as much as anybody else, regardless of what pricing is used.” , they probably are upset that they did not get the higher rate , as anyone would be , but as with any investment , you can wait for higher , lower etc etc and never do anything . maybe i am just not getting why this seems to be such an issue for you .
” So if I buy a 5-year GOC and sign a contract in blood stating that I will hold it to maturity, can I get historical cost reporting for my investment too?” james i think you meant gic .
No, I meant GOC. If the only difference is the ability to trade, can I give up this privilege to gain equal treatment?
the people that i talk with (and try to talk out of buying gic instruments) , tell me oh no i cant stand any loss . i think they are very happy that the gic does not ever show less than 100.00. …. maybe i am just not getting why this seems to be such an issue for you .
They are being lied to. This is not a good foundation for an investment strategy, or for ethical marketting.
” They are being lied to. ” james , i do not agree , gic buyers know up front there is no market and they are in until the maturity date . if they didnt want that , then they would buy preferreds , goc bonds or stocks .
” They are being lied to. ” james , i do not agree , gic buyers know up front there is no market and they are in until the maturity date .
They are being lied to about their account value, unrealized gains or (nowadays) losses and their performance. If we are to believe our brokerage reports, 5-year GICs have recently been strongly outperforming short-term bond funds.
” They are being lied to about their account value, unrealized gains or (nowadays) losses and their performance.” , in the case of no after market gic, that can only be turned into cash at maturity i just can not see your point that there are unrealized gains or losses . the statement could show it at 50 or 150 , but with no way to sell i dont see that it is valid , or meaningful . i think on this we are going to have to agree to disagree . i have been blocked on some blogs for trying to do a back and forth , like this , so thankyou for not blocking me . i love the blog , it is an amazing education , and i find the comments add a lot . thanks again .
i think on this we are going to have to agree to disagree
Looks like it. But before signing off, I’ll just leave a note about how GICs are sold, from the article Use of GICs for ‘safety’ grows but experts see high quality bonds as more flexible:
i have been blocked on some blogs for trying to do a back and forth , like this , so thankyou for not blocking me .
Disagree all you like. The only thing I get irritated with is deliberate and repeated disinformation.
james , i would have to register as an advisor to read it , but the quote you provide “you have no market movements” is exactly why the people that buy gics buy them and why they dont want to know market pricing as int rates fluctuate . and the banks know that and market them like that . okay now i am done . thankyou
“So if I buy a 5-year GOC and sign a contract in blood stating that I will hold it to maturity, can I get historical cost reporting for my investment too?”
This is the principal behind “held-to-maturity” accounting, which is and has been dealt with by various international accounting standards (e.g. FAS 115) over the years. The basic idea is that investment entities with the ability and willingness to hold a debt security to maturity can mark to model rather than market.
This is a useful concept for matching future expenses with current cash (like insurance payouts or using GICs to save for a boat). If the investor entity has no need to accommodate a premature liquidation, constantly marking to market is not their reality.
That is not to say that James’ examples are incorrect. They surely are, that GIC bought today is, in a liquidation scenario, absolutely not worth the same amount tomorrow. It just doesn’t matter in a held-to-maturity scenario.
This is the principal behind “held-to-maturity” accounting, which is and has been dealt with by various international accounting standards (e.g. FAS 115) over the years.
FAS 115 has at least one saving grace:
… so at least investors who don’t want to be lied to can can adjust the published financial statements to something more closely reflecting reality.
The interesting part is … why would a corporation wish to publish such crap? Here’s one take:
In other words, to lie about the company’s financial condition.
Here’s another justification:
Less riskier? Lesser beta? Hedge against market fluctuations?
Lies.
Look, if a company feels that hedging a portfolio of bonds would be more trouble than it’s worth, I don’t have a problem with that. That’s a business decision. But I have immense problems with reporting fairy tales as if they were unvarnished truth.
I will also note that money market funds are allowed to use ‘hold to maturity’ accounting, the regulators conspiring with the salesmen to allow lies to be told to investors. This can have grievous consequences for investors since in an environment of rapidly and surprisingly rising money market interest ratees, it becomes advantageous for large investors to sell their fund investments (at historical pricing) to buy market-priced investments. If I remember correctly, this became an issue at one point, but I can’t remember the upshot. It would be most interesting to work out how much money has been syphoned away from gullible small investors by big boys employing this strategy in the first half of this year.
It is also my belief that ‘private equity’ is also used to lie about financial position, since the lack of an active market allows a plausible rationale for valuing the investment based on cash flow discounting with a discounting factor that is, shall we say, considerably more stable than market prices. Sadly, it is very difficult to get detailed information on this issue and therefore difficult to write thundering denunciations of the practice – assuming that it is the practice. I can’t tell for sure, you have to be an insider.
I recognize that investors want stable, predictable returns. But when an investor comes to me and says ‘I want unicorn tails and fairy dust!’, it is my responsibility as a financial professional to tell them that they can’t have it.
This is a useful concept for matching future expenses with current cash (like insurance payouts or using GICs to save for a boat).
That’s immunization. Immunization works, mostly, but frictional costs can be fierce if one intends to pursue an active strategy. However, if you want to buy a strip bond as a one shot cash-flow-matching strategy, there’s nothing wrong with that. And I have no objection – indeed, I support – showing the obligation being financed on the books as a liability that also fluctuates with interest rates.
“But I have immense problems with reporting fairy tales as if they were unvarnished truth.”
This is the rub. Reporting. I agree with James’ outrage (getting back to the original thread) about reporting GIC value in account statements. Marking-to-model is the choice of the investor (on their own dashboards or asset summaries), not the reporting entity. We can “lie” to ourselves but it should not be purview of financial industry to do it for us.
It’s all kind of wierd. If I sell a short term treasury bill fund to my client they bail because the fund will decrease with a rise in rates. But if I sell them a money market fund with a lower yield they are happy because they can’t lose. In real life I recently lost a long term million dollar client to a GIC because I don’t have enough energy to keep explaining his losses on a short term bond fund are temporary. Banks have a huge advantage in not having to report a GIC at market. As for setting aside capital, I think the regulators let cash be cash, discount GICs 5%, and had no slot for preferred shares so they treated them like equities. As for distrust in the industry, I do remember a few mutual fund distributors (I think 3 at that time) being sued and having to pay damages due to market timing of client funds a number of years ago. AGF and Templeton were two of them.
As for distrust in the industry, I do remember a few mutual fund distributors (I think 3 at that time) being sued and having to pay damages due to market timing of client funds a number of years ago. AGF and Templeton were two of them.
Well done Dan! This was way back in 2005 and involved stale prices of some kind, but I’m not sure if money market funds and historical pricing were part of the proceedings.
I recently lost a long term million dollar client to a GIC because I don’t have enough energy to keep explaining his losses on a short term bond fund are temporary.
My sympathies, Dan. I wrote about that issue back in March 2010 … but sadly, my essay did not change the world.
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