The following blog post is about Canadian Preferred Shares specifically, and my first experience purchasing them, how I came to decide that it was time to buy, what I bought, and my overall learning experience.
A few weeks ago I mentioned in one of my blog posts that I took a trip to Montreal and Ottawa, Canada, over the April Easter long weekend to visit family in both cities.
Here’s what I wrote in the post:
“I’m also lucky enough to have my in-laws, two wonderful people who I’ve known for over 30 years. Earlier this year, my mother-in-law had a health scare that could have ended in a disaster.”
As a result of her near-disaster, it’s occurred to my in-laws that it might be time to share their investment portfolio and account information with my wife and, in turn, me for advisement and assistance moving forward.
Over the last many years, my mother-in-law frequently asked me about my thoughts on the markets. I almost always answered that since 2000 I’ve more or less stayed clear of the stock markets and instead established a different investment allocation, my 3 buckets, that has worked for me for so many years. If you’re new to this blog, you can download my book here.
It so happens that my mother-in-law was quite the investor, which I discovered when I reviewed her trading statements. She has many holdings in her portfolio, but one part of her allocation that caught me by surprise was how many individual preferred shares she owns.
Up until mid-April, I was mildly familiar with preferred shares. It isn’t an asset class that I paid much attention to, but now that I was asked to advise on her portfolio, I had to do some exploration.
With a fresh cup of coffee in hand, I entered all of her securities into a Google Sheets document. It took some time because she has registered accounts (retirement and tax-free), and non-registered accounts. She has American and Canadian stocks. Broker advised and personal trading accounts. She has a long list of fixed income and quite a few stocks, both common, and about 15 individual Canadian preferred stocks.
In the end, her allocation looks as follows:
GICs (T-Bills) = 43%
Canadian Preferred Shares = 33%
Common Shares = 13%
Cash = 11%
My initial inclination was that my mother-in-law’s portfolio is too equity heavy. If you classify Canadian preferred shares as an equity investment, she has almost 50% of her portfolio in the equity markets. That’s clearly too much for an older retiree.
Canadian Preferred shares weren’t something I had ever paid much attention to.
I had to pay attention now.
Is my mother-in-law’s portfolio appropriately diversified?
Are preferred stocks considered equity or fixed income?
Logic would dictate that given the name “preferred shares,” they should classify as equity, but how should they be classified in a portfolio?
Time to do some research.
What Are Preferred Shares, and Should You Invest in Canadian Preferreds?
Technically, preferred shares are shares (stocks), BUT they resemble bonds, in that they pay a steady stream of quarterly dividends. They are typically impacted by changing interest rates, inflation, and credit spreads and, in that regard, trade up and down in a similar manner to bonds.
With regards to asset claims in the event of a bankruptcy, they fall behind bondholders and ahead of common equity, but if you’re purchasing a solid blue-chip preferred share from TD Bank, Enbridge, or Bank of America, for example, then there probably isn’t too much to worry about.
Preferred shares are almost always issued at $25 per share and, again, go up and down based on interest rates, credit spreads, inflation, and credit rating. Because they pay dividends rather than interest, the holder receives a dividend tax credit.
A TD Bank Canadian preferred share, for example, TSE:TD.PF.J, has a current price of $20.55 and currently yields 5.3%. This particular share was issued at $25 at 4.7%, but since the share is trading at $21.10, it now yields 5.3% ($25 × 4.7% ÷ $21.10).
If the share drops to $20, for example, the new yield pays $25 × 4.7% ÷ $20 = 5.87%. The variables that make the share trade up or down on a daily basis are generally not based on the creditworthiness of the underlying issuer. And since most issuers in Canada (and the US) are blue-chip, the yields on most preferreds trade based on a macro (inflation, interest rates) rather than microeconomic news.
If you compare the list of preferred shares from Canada’s biggest banks, you will notice that they trade within a small band of interest rate differentials, meaning a TD Bank share will yield a very similar yield as a BMO share.
The preferred share dividend yields a preferential after-tax return than you would otherwise yield from interest income because the quarterly payments are considered a dividend and not income and, as such, receive the dividend tax credit.
If you are an Ontario (Canada) resident earning $100,000 a year, the interest equivalent yield needs to be multiplied by approximately 1.3, meaning the above-mentioned TD preferred share yielding 5.3% would need to yield 6.89% if held as bond income to provide a similar after-tax return.
The 3 types of Canadian preferred shares: fixed resets, perpetual, and floaters.
- Fixed resets preferred shares: pay a fixed dividend for 5 years and are reset 5 years later based generally on where interest rates stand at that time. The issuer has the option to call the preferred share at the 5-year mark, generally at the $25 issuance price, which means if your share is trading at $22, and the issuer calls the shares at $25, you make a profit of $3 per share. Rate reset shares perform better in a rising rate environment.
- Perpetual preferred shares pay a fixed dividend in perpetuity (not 5-year increments like fixed resets) and generally can be called at any time at $25 a share. Perpetuals generally do better in a declining rate environment.
- Floaters pay a floating dividend that is based on the prime rate and do better in a rising rate environment.
If you have a longer-term perspective, buy the share at below $25, and are looking for a steady stream of income, you can hold the preferred share forever and clip your dividend coupons. You will need to ignore the daily fluctuations of the share price and focus on the dividend instead, which will remain constant.
Remember, the share price could drop, as they did during the fall of 2018, but when the share price decreases, the yield will increase, and vice versa, so your payments remain constant. If you plan to buy and sell your securities, you will have a capital gain or loss, but if you plan to hold indefinitely, you shouldn’t be too bothered by the daily fluctuations in the share price.
I discovered that my mother-in-law was on to something.
I’ve since purchased 11 different preferred shares for my own portfolio, which yield over 6% before tax, and I plan to add more to my portfolio over time. I now classify these securities as fixed income in my portfolio, and thanks to my mother-in-law, I’m more comfortable with this asset class.
If you’re just getting started with investing in preferred shares, you might want to consider an ETF, such as the BMO S&P/TSX Laddered Preferred Share ETF, TSE:ZPR, or CPD, as an alternative to investing in individual securities. Preferreds shouldn’t comprise more than 10%, maybe 15%, of your overall portfolio.
The Canadian preferred shares I’ve bought are as follows (I am providing my shares as a reference only), and certainly not an indication of the best preferred shares Canada.
How to Buy Preferred Shares Canada:
The best route to purchase preferred shares in Canada includes purchasing directly from most of the major brokers. That includes discount brokerages, such as:
TD Bank: TD Bank Canada Webbroker
BMO: BMO Investorline
Royal Bank: Royal Bank Trading Platform
Scotia Bank: Scotia Bank iTrade
QTrade: QTrade Investor
Research Information – Pref Blog:
What is the Difference between: ZPR vs CPD:
Earlier in the article, I mentioned the ETF ZPR. and I also mentioned CPD.
ZPD is: BMO Laddered Preferred Share
Don’t be followed by the word laddered in the name ZPD. They are essentially both laddered preferred shares, and they both hold a basket of Canadian preferred stocks.
Best Preferred Shares Canada:
(Stock symbols mentioned in this post include): NOTE, this is my opinion, and should NOT be used to trade preferred shares.
TSE:BIP.PR.A, TSE:ENB.PR.J, TSE:BCE.PR.C, TSE:BPO.PR.R, TSE:BPO-P, TSE:SLF-B, TSE:TD.PF.J, TSE:TD.PF.F, TSE:MFC-C, TSE:FFH-C, TSE:FFH-I, TSE:WN-A, TSE:NA-S, TSE:CWB-B, TSE:CCS-C, TSE:PWF-K, TSE:FTS-K, TSE:BAM-E, TSE:BAM.PF.C, TSE:IFC-F, TSE:CF-C, TSE:LB-H, TSE:BRF-E, TSE:RY-O, TSE:CIU-A, TSE:GWO-M, XPF, CPD
Before you go, here’s another article I think you might enjoy: Long-Term Investing Buy and Hold Strategies That You Can Use for a Lifetime.
In the future, I will post additional articles on the Canadian Preferred Share Blog.
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Stock symbols mentioned in this post include: TSE:BIP.PR.A, TSE:ENB.PR.J, TSE:BCE.PR.C, TSE:BPO.PR.R, TSE:BPO-P, TSE:SLF-B, TSE:TD.PF.J, TSE:TD.PF.F, TSE:MFC-C, TSE:FFH-C, TSE:FFH-I, TSE:WN-A, TSE:NA-S, TSE:CWB-B, TSE:CCS-C, TSE:PWF-K, TSE:FTS-K, TSE:BAM-E, TSE:BAM.PF.C, TSE:IFC-F, TSE:CF-C, TSE:LB-H, TSE:BRF-E, TSE:RY-O, TSE:CIU-A, TSE:GWO-M, XPF, CPD