When the Bank of Canada says interest rates will remain low for a long time you know the prospects for savers will remain bleak. Regardless, fixed income remains an essential part of an investment portfolio to cushion risk on the equity side.
After more than a decade of rock-bottom interest rates, the need for yield has stretched the limits of what is considered fixed income; pushing investors to alternative income sources such as preferred shares.
They have qualities of both stocks and bonds, but in the end preferred shares are a little of both and not much of either.
What is preferred stock?
Preferred shares are an equity or ownership stake in a firm. Specifics vary among issuers but preferred shareholders generally have a higher claim to dividends than common shareholders if they are at risk of being suspended as we’ve seen in several situations following this winter’s economic freeze.
In the event of liquidation, preferred shares also have a greater claim to company assets than common shares, but less than bondholders.
Is it fixed income?
Preferred shares typically pay out slightly higher yields than guaranteed investment certificates (GICs), government bonds, or even mid-grade corporate bonds.
Specific yields vary depending on many factors but currently pay out as much as seven per cent annually. They are rated according to default risk like bonds, so those with the highest credit quality tend to have the lowest yields.
Right now, GICs pay out about one per cent, but like the name implies that one per cent payout is guaranteed. The issuer of preferred shares can giveth and taketh yield as it sees fit and they have no maturity date.
If you consider fixed income as income that is fixed; preferred shares are probably not for you.
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Is it equity?
Preferred shares trade on the open market and can be purchased like any stock. But while broader equity markets have been rallying lately, preferred share prices have actually fallen as their appeal as income generators diminishes. Even if you factor in yields, total returns have been dismal over the past decade.
Prices of preferred shares tend to lag their kindred common shares and usually trade close to their issuing price. They might be seen as a bargain if the company’s underlying fundamentals are good.
Unlike common shares, preferred shares do not provide voting rights, which probably doesn’t matter to the average investor but it’s worth noting.
Retail investors can access preferred shares through many types of exchange-traded funds (ETFs) such as iShares S&P/TSX Canadian Preferred Share Index ETF Common Class. It tracks the Toronto Stock Exchange Preferred Share Index but posts a year-to-date loss of 11.4 per cent once you factor in the 0.45 per cent annual fee.
Is it either?
It’s hard to find a money manager or investment advisor who is thrilled about preferred shares. Many are reluctant to go on the record because their firms offer preferred shares or preferred share packages.
They also say many preferred issues lack the liquidity of common shares, which can make them difficult to price at any given moment, or trade in a pinch.
Institutional investors often invest in preferred shares for certain tax advantages not available to the average investor. In some cases they can make sense for retail investors seeking income, particularly if a large portion of their investments are in taxable accounts.
In the end, it depends on the specific situation of the individual investor. It is best to talk to a qualified advisor to see if preferred shares are right for you.
Payback Time is a weekly column by personal finance columnist Dale Jackson about how to prepare your finances for retirement. Have a question you want answered? Email email@example.com.