Hello, Darcy! This should be fun today ... the market is very nervous!
James, just to start off, can you provide us with a bit of an explainer on what preferred shares are - and why they've been selling off this past week?
Preferred shares are securities issued by companies that they may count as equities for bookkeeping purposes (other than retractibles, which count as bonds) but have other characteristics more like debt...
They (almost always) pay eligible dividends and have a very high "liquidity premium". This makes them very attractive to very many retail investors in their taxable accounts.
And the reason for the selloff this week?
There has been musing at the Fed (primarily Bernanke at the press conference following the last FOMC meeting) that the Quantitative Easing programme (by which the Fed is buying a great many long-dated securities) may taper off commencing in the fall ...
Without this source of market support, many investors are afraid that market yields of all kinds will skyrocket, particularly long rates. As preferred shares are long-dated fixed income instruments (in general) there is therefore fear of imminent capital loss.
I think these fears are overdone. The global economy isn't doing very well even with all this stimulus.
James, it's very hard right now for investors to make income. Once reliable dividend stocks and REITs and even preferred shares have plunged as bond yields have unexpectedly soared. And we all know high interest savings accounts, with the rates they are offering, aren't providing a great answer right now. Do you think this is a good or bad time to buy more preferred shares for one's portfolio? In other words, what's your short and medium term outlook for preferreds right now?
I don't indulge in market timing; although I will go so far as to say that I believe the preferred share market will face headwinds over the next few years as government rates increase dramatically, corporate bonds to a lesser extent and preferred shares to a lesser extent still....
Investors should not attempt to time the market, although the temptation can be at times overwhelming. Your portfolio should be constructed according to your needs and with the long-term characteristics of each asset class at the forefront.
Market timing is a mugs' game.
Let's take a few questions from our readers today
1. Whether or not they are a better buy depends very much on your portfolio objectives, and on the specific characteristics of the shares involved. Asking whether FixedResets are a better buy than PerpetualDiscounts is much like asking whether potatoes are better than carrots.
That being said, current-coupon FixedResets are (as of Friday's close) at the high-end of their valuation range against perpetual discounts, as measured during the Credit Crunch.
2. Asking whether or not to dive in now is a market timing question! If they meet your needs and you have room in your portfolio, it's a good time to buy. If not, then no.
2. That being said, spreads of preferreds against corporate bond have exploded in the past month (to over 300bp vs. a post-Crunch average of 200bp), so they are more attractive now versus corporate bonds than they have been in a long time.
@Robert, you never want to be in the position where you are a forced-seller because not only can the market be very thin, but occasionally the preferred share market, with its overwhelming retail participation, goes blahooey. This was the case during the Credit Crunch and to a lesser extent (so far!) it is the case now.
@Robert: Planning is key. For money you might need in the short term, you want to have a segment of your portfolio in Short Term Bonds.
@Gentlemenpreferpreferreds: Flattery will get you everywhere!
@Michael: It should be remembered that FixedResets are perpetual instruments - just as perpetual as Straights. While the FixedReset structure addresses interest rate risk, it does not address Credit Risk, as investors in issues such as YLO, FN, AZP, etc. have found to their chagrin....
@Michael: The question of whether or not we should analyze a FixedReset as a perpetual will depend on its Issue Reset Spread, not its current dividend. Some of the old bank issues, with Issue Reset Spreads of over 400bp are virtually certain to be called at the first opportunity. Other issues with smaller spreads (TRP.PR.B is the poster-child for this class) should be assumed to last forever.
@burned: It's a complicated question. It is indeed true that preferreds, by themselves, are tax-inefficient for the issuers. But they are junior to bonds (as YLO holders, and Nortel and Quebecor World found out rather dramatically)....
@burned: Thus, a company that issues preferreds will be able to sell its bonds at a lower yield, since the bonds will be safer with a greater amount of subordination...
@burned: there's a great deal of academic research on proper capital structures, but for many companies, spending an extra $1-million on preferred dividends is very well worth it if they can thereby save $2-million in bond interest payments.
Hmm, links don't work properly here ... but you can work it out.
James, should investors be wary of companies like Enbridge issuing so many preferred shares, as they have this year? In other words, are they just taking advantage of unsuspecting retail investors who want yield?
Issuers never issue any securities because they want to make the world a better place. They have their own interest first and foremost. As I said before, each issue has to be examined in the context of whether it meets the investor's needs....
That being said, I will note that most new issues are expensive: there have only been two new issues in the last ten years that were worth buying given market conditions at the time. ...
Fortunately, new issues pay the salesmen a 3% commission that the investor can pretend doesn't exist, so the issuers, in general, don't have to pay market rates for their new issues.
The new issues that I liked, by the way, were BNA.PR.C and CGI.PR.D
And, such is life, BNA.PR.C dropped like a stone immediately following issue. CGI.PR.D has held its own since issue at the end of May.
@Smith: I am not aware of any useful statistics on duration mis-match strategies - that tends to come out after a crash (such as Orange County following the 1994 bond market debacle)