David Berman has nibbled on preferred shares issued by Royal Bank of Canada and a host of other institutions.Cole Burston/The Globe and Mail
When you start constructing a portfolio that will generate cash in your retirement – or hey, you just like the idea of steady income today – preferred shares may be worth a look.
They beckon with yields north of 5 per cent, which is significantly better than current yields on government bonds and guaranteed investment certificates (GICs).
And when held in a taxable account, the distributions from preferred shares receive favourable treatment from the government.
But are they still a good deal?
Preferred shares are fixed-income investments that straddle the world of stocks and bonds. Like stocks, they trade on exchanges throughout the day, at fluctuating prices. Similar to bonds, they’re issued at a “par” starting price – usually $25 – and don’t reward investors with a share of the profits.
When rates rose in 2023, as central banks battled surging inflation, these shares took a beating. Shares initially priced at a par of $25 fell below $20 in many cases, as bonds, GICs and money market funds emerged as attractive alternatives.
Investors still received their distributions, but the value of their initial investments plummeted, leaving them with potentially steep losses.
But there is an upside, too: When interest rates fall, preferred shares can shine. That’s what’s happening today.
With interest rates down substantially over the past couple of years, preferred share prices have bounced back from their lows in 2023. The RBC Canadian Preferred Share ETF, one example of a fund that provides one-stop diversification, has rebounded 55 per cent from a low in 2023.
Over the past several years, I’ve nibbled on preferred shares issued by Royal Bank of Canada (now redeemed), Power Corp. of Canada, Brookfield Property Partners and, most recently, Fortis Inc. I focus on shares trading at, or ideally below, par.
Some readers weighed in with their own experiences after I wrote a couple of recent articles in this newsletter about where to find attractive investments that generate cash.
One reader set his sights on beaten-up preferred shares that traded well below par in recent years, and then waited out the interest rate cycle. For diversification, he also bought units in the BMO Laddered Preferred Share Index ETF.
Another reader celebrated the joy of receiving steady distributions even when share prices fluctuated, knowing that the redemption price would always be $25.
“Preferred shares are boring, predictable and in my opinion one of the coolest things to own in retirement,” he said in an e-mail.
Here’s the wrinkle: If you could score preferred shares at deeply discounted prices – and hefty yields – three years ago when interest rates were high, are the good deals gone now that share prices have rebounded?
I spoke with John Nagel, managing director of preferred shares at Leede Financial in Toronto and one of Canada’s foremost experts on these assets.
His point: Despite rising prices, investors can still score shares that trade below par.
“Ideally, when you’re buying a preferred, you buy below par. Because if something happens and it gets redeemed, you’ll have a capital gain,” Mr. Nagel said.
One example: Enbridge Inc.’s Series R shares could be bought for $23.80 on Tuesday morning, for a yield of 6.6 per cent.
Though the yield will be reset in 2029, the next few years look great. And since preferred shares are taxed more favourably than bonds, that’s equal to a bond yielding about 8.5 per cent (the exact number will vary by province).
Other preferred shares might offer slightly lower yields of about 5.6 per cent – but the distributions will flow until the shares are redeemed.
That said, preferred shares aren’t for everyone, mostly because they can be complex. Investors should be aware of redemption criteria and know how yields are reset. And some familiarity with what the shares will do in a rising or falling interest rate environment is crucial.
But for yield, they’re hard to beat right now.
Is generating income from your portfolio important to you, or are you more focused on stocks that can zoom to the moon? Let me know your approach at dberman@globeandmail.com.
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