Canadian preferred shares: Greedy or Fearful?

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Norbert Schlenker
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Canadian preferred shares: Greedy or Fearful?

Post by Norbert Schlenker »

There are a few threads now where there have been exclamations about the fast and furious recovery in the prices of preferred shares since the worst days last November and December. For investors who bought then, it's hard not to be complacent, if not triumphant, regarding what are big gains, in some cases doubles or better. It certainly looks like a happy lesson that buying highly rated bank preferreds to yield 9-10%, or lower rated stuff at 11-15%, is a low risk no lose proposition.

Yields on high quality paper, like bank issues, are now typically 5.5% for perpetual issues, sub 5% for the newer 5 year reset issues. Somewhat more questionable issuers have long paper trading at under 7% yields. Double digit yields are only available from truly garbage credits.

Have investors learned the right lesson? Is it really the case that the credit crisis cannot return and spreads blow out again? Is inflation dead for a generation?

Is anybody, other than me, getting a little fearful that future risks are not being properly priced today and thinking about cashing some gains?
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Post by bpither »

I bought top quality CDN bank perpetual discounts and one BAM (pfd 2) in early February which represent 30% of my portfolio. I considered this investment after reading James Hymas and his belief that the valuations haven't been so good since 1993/94 ... and remain astounded at their rebound. As an income oriented investor I'll hang in there until inflation returns and prices drop, but I just don't see it in the near future.
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Post by queerasmoi »

I would not count out the possibility of a correction in corporate fixed-income valuation (including corp bonds, prefs, etc). It seems we went from an irrationally harsh undervaluation during the crisis to a moderately irrational overvaluation. Investors are starting to move out of cash, but not completely into the market yet... into bond funds, prefs, balanced funds. Suddenly a huge amount of investor attention is focused on these yields.
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Post by AltaRed »

I am not fearful regarding the quality of the Big 5 bank preferreds, even the perpetuals which I own. The biggest fear I have is inflation and no one knows how that is going to play out given unprecedented(?) deficit spending by OECD countries. I am not looking for home runs with my investment portfolio.

Having said that, keeping IMO, more than 20% of one's portfolio (50% of the FI component) in preferreds is insufficient diversification.
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Post by couponstrip »

Norbert Schlenker wrote:It certainly looks like a happy lesson that buying highly rated bank preferreds to yield 9-10%, or lower rated stuff at 11-15%, is a low risk no lose proposition.
It looks that way now. However, there was real risk in buying those prefs at that time. Perhaps, in retrospect, it seems that the market priced them too low based on the risk which is now better known, but with the information at hand in Nov-March, the market was doing the best it could with the limited information available, and prefs (along with all common equity) were being priced in consideration of the possibility of a depression-like collapse of the world financial system. Those buying preferred or common equity in those dark days (or corporate bonds etc etc) risked their capital, and are being rewarded.

As for where things go from here, well that will depend on information yet to be presented. :D

I keep reading in the business section of the newspaper about the expected correction/crash in the fall (presumably a few weeks from now), so that makes me think that there will be a slow and steady march up to TSX 12,000 by year end. :wink:
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Re: Canadian preferred shares: Greedy or Fearful?

Post by scomac »

Norbert Schlenker wrote:<snip>It certainly looks like a happy lesson that buying highly rated bank preferreds to yield 9-10%, or lower rated stuff at 11-15%, is a low risk no lose proposition.<snip

Have investors learned the right lesson?
To my way of thinking, that's not the "right" lesson. The correctly lesson is that liquidity is golden in times of turmoil and you will be handsomely rewarded to provide liquidity for quality. I would not consider this a no lose proposition, but rather low risk/high return.
Is it really the case that the credit crisis cannot return and spreads blow out again?
There will always be a chance particularly when the degree to which business will recover maybe beginning to be overstated. What we need though will be is a major catalyst to push us over the edge. In many ways, I wonder if the most recent strength in preferreds is a result of MFC cutting the dividend on the common. All of a sudden, the market has a concrete example of the benefits of preferred share ownership.
Is inflation dead for a generation?


As long as the supply of goods and services continues to exceed the demand, then it is hard to envision persistent inflationary pressures any time soon. To infer that inflation maybe dead for a generation is in all likelyhood, wishfull thinking.
Is anybody, other than me, getting a little fearful that future risks are not being properly priced today and thinking about cashing some gains?
I don't know whether it's fear or prudence, but I have placed a number of limit orders out in front of several positions, both common and preferred equity. When YTW's go negative, it's probably past time to take leave.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by kcowan »

scomac wrote:In many ways, I wonder if the most recent strength in preferreds is a result of MFC cutting the dividend on the common. All of a sudden, the market has a concrete example of the benefits of preferred share ownership....
IOW they went from overly depressed in November to somewhat bubbly now? The bubble will go away when either:
- other dividend payers do not cut, reinforcing the bubble nature of the current pricing, or
- other dividend payers do cut, reinforcing their current valuations as a flight to safety.
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Post by sweedy »

For the next 10 years, given the risk of inflation, my choice is floating rate preferred. Unfortunately I cannot take too much position because there are only a few floating rate issues which offer undiversified choices.
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Post by kcowan »

OTOH MFC is back above $22.31 so what is that all about?
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Re: Canadian preferred shares: Greedy or Fearful?

Post by marty123 »

scomac wrote:The correctly lesson is that liquidity is golden in times of turmoil and you will be handsomely rewarded to provide liquidity for quality. I would not consider this a no lose proposition, but rather low risk/high return.
That's how I see it too. Prefs are illiquid with almost no institutional holding. Traditionally conservative investors got alerted of risk prefs and just dumped them without enough buyers. Greedy speculators and investors made a killing.

The next lesson, IMHO, is that the investors who recently bought and the investors that are still holding are not providing the same liquidity benefits to the market. 6-9 months ago, the risk/reward benefit was much better than it is now, and if I were holding these securities, I'd be rebalancing to what should be an acceptable long-term allocation.
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Post by like_to_retire »

Is anybody, other than me, getting a little fearful that future risks are not being properly priced today and thinking about cashing some gains?
I have looked at the rise of preferreds and the present prices to be a returning to normal rather than anything frothy. I think they're still underpriced somewhat. Its my understanding that the long term Canada Bond rates and subsequently the spread up to long term corporates that determines the normal pricing of preferreds.

From pref blog, I understand historic normal levels of preferred pre-tax interest-equivalent spread to be 100bp-150bp above long term corporates. If preferreds are at 5.6%, then that's equivalent to 7.84% interest equivalent. Since long term corporates are at ~6.0%, then we're at a spread of ~184bp. Prices of preferreds still need to rise a bit more to get to normal levels. Corporates rates may also lower their spread to Canadas further, and this will raise preferred prices further.

Sure, when inflation does increase, preferred prices will drop, but this recent pricing increase is just a returning to normal and reflecting long term rates.

Of course, I've been wrong before.....

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Post by adrian2 »

Greedy or Fearful?
Neither, just returning to a normal weighting and happy to take profits. Was I early? Yes, as usual, on both sides.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by Dennis »

My non registered account with TD Waterhouse now holds only cash, as in DYN 500, the Dundee high interest account. I am looking for more return as well as preservation of capital (I am 66 and need to draw on this account for any major purchase). At the moment, my preference is to buy CPD-T, the Claymore Preferred ETF. I realize the downside here if interest rates climb and I prefer not to be subject to currency fluctuation.

Does this look like a good bet or does anybody here have a better idea? I am not prepared to delve into the complexities of preferred shares myself.

Thx in advance for any input here

Dennis
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Re: Canadian preferred shares: Greedy or Fearful?

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Dennis wrote:My non registered account with TD Waterhouse now holds only cash, as in DYN 500, the Dundee high interest account. I am looking for more return as well as preservation of capital (I am 66 and need to draw on this account for any major purchase). At the moment, my preference is to buy CPD-T, the Claymore Preferred ETF. I realize the downside here if interest rates climb and I prefer not to be subject to currency fluctuation.

Does this look like a good bet or does anybody here have a better idea? I am not prepared to delve into the complexities of preferred shares myself.

Thx in advance for any input here

Dennis
CPD should be treated as equity as it can be quite volatile. Last year it provided a bonus, but who knows what the future will bring.

I hold CPD, although am thinking of reducing my exposure and have been looking at CAB-T. It is a new high quality Canadian government and corporate bond product offered by Claymore that uses derivatives to change interest income into capital gains (otherwise it should give you close to what XBB-T would. I have not yet decided to pull the trigger as I am not sure if I should trust this product.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by AltaRed »

northbeach wrote:I hold CPD, although am thinking of reducing my exposure and have been looking at CAB-T. It is a new high quality Canadian government and corporate bond product offered by Claymore that uses derivatives to change interest income into capital gains (otherwise it should give you close to what XBB-T would. I have not yet decided to pull the trigger as I am not sure if I should trust this product.
I think the biggest issue is the boutique nature of such a product (CAB). Will it get enough volume? Will it last? How efficient (low cost) will it really be? CPD should be an obvious choice by retail investors at large, particularly if retail investors are already saturated with dividend common stocks, but it doesn't seem to have a very large following yet.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by Norbert Schlenker »

Dennis wrote:I am looking for more return as well as preservation of capital
Dennis, you know that's a contradiction right off the bat.
At the moment, my preference is to buy CPD-T, the Claymore Preferred ETF. I realize the downside here if interest rates climb
It's more than that. Look at a chart of this product. Interest rates were not climbing in November 2008 and CPD went from 18 to 13. Is preservation of capital important or not?
Does this look like a good bet or does anybody here have a better idea?
I am unconvinced that it satisfies your criteria. If you really want preferreds, then you could also look at DPS.UN, which is trading at a fat discount to NAV these days, but be prepared for their tax shenanigans.
AltaRed wrote:...(CAB). Will it get enough volume? Will it last? How efficient (low cost) will it really be?
Will the taxman leave it alone????
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Re: Canadian preferred shares: Greedy or Fearful?

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AltaRed wrote:
northbeach wrote:I hold CPD, although am thinking of reducing my exposure and have been looking at CAB-T. It is a new high quality Canadian government and corporate bond product offered by Claymore that uses derivatives to change interest income into capital gains (otherwise it should give you close to what XBB-T would. I have not yet decided to pull the trigger as I am not sure if I should trust this product.
I think the biggest issue is the boutique nature of such a product (CAB). Will it get enough volume? Will it last? How efficient (low cost) will it really be? CPD should be an obvious choice by retail investors at large, particularly if retail investors are already saturated with dividend common stocks, but it doesn't seem to have a very large following yet.
I,too, have been looking at CAB but I'm put off by its low liquidity. Every day there are a few orders for 300 lots (boards?) on both the buy and sell side, in addition to some stray orders by individual investors. I don't understand why these large orders are being placed, pennies apart in price, on a stock that just started trading two months ago and is, presumably, meant for the buy and hold crowd.

Norbert, do DPS.UN's tax shenanigans arise because it is an income trust and 2011 is approaching of its structure? Or is there something else going on?

edited to correct type and to take Arby's comment into account
Last edited by Pickles on 13 Jan 2010 10:49, edited 1 time in total.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by Arby »

Pickles wrote:...do DPS.UN's tax shenanigans arid=se because it is an income trust and 2011 is approaching?
DPS.UN is not an income trust. The ".un" suffix does not mean a stock is an income trust. The ".un" suffix is used by the TSX for various types of non-standard investments, including income trusts, split shares, closed end mutual funds, etc.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by ThinkDividends »

I placed an order for the IPO of Brookfield Properties 6.15% rate resets on Monday at 5 PM.

I requested 2,000 shares... I got 0 !!!

Everyone is going gaga for theses new issues...
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Re: Canadian preferred shares: Greedy or Fearful?

Post by Nowhereman »

E Mail notification of new issues is a total charade, the Banks have scooped all the good issues, if it still open, it is garbage.

The only way to buy them is when they trade on the open market.

ONCE, I grabbed some Baytex, it has doubled, but after some rocky rides.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by like_to_retire »

Everyone is going gaga for theses new issues...
And it makes no sense at all. The prices being paid for resets is silly. I can't imagine the buyers have calculated yield to reset - and won't be particularily happy when they're handed par after paying ~$27.

As far as the latest BPO rate reset goes, you can get a retractable BPO.PR.H today at 23.60 with a current yield of 6.1% and a YTW over 7%. Why is the reset so popular? Makes no sense - the retractable has a guaranteed put that gives the holder some control.

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Re: Canadian preferred shares: Greedy or Fearful?

Post by Peculiar_Investor »

This post, RY.PR.R Bid at under 3% Yield, by James Hymas got me thinking. I took an initial foray into the preferred share world with an IPO purchase of TD.PR.G at the beginning of last year. The March 29th PrefBlog shows TD.PR.G at $28.25, with a YTW of 3.22%.

So I'm thinking that I'm going to receive four years of dividend payments @ $1.5625 or $6.25/share and then I'm expecting that at first chance the shares will be redeemed at par. On the other hand, I'm sitting on a capital gain of $3.25/share. I'm trying to work through the math to determine whether it is worthwhile to continue to hold or perhaps it is time to capture the capital gain and re-invest elsewhere, particularly since I am not reliant on the income stream to cover living expenses. My gut is telling me take the capital gains and find another opportunity, but I'd like to based the decision on more than gut feel. Can anyone of the experience preferred share investors offer guidance on factors to review and/or the math to consider.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by scomac »

I wouldn't necessarily be in any rush to sell just yet. With the appearance of this latest fixed/reset financing IPO, there could be some more upside to your preferred share if this new issue is well received. I'm dumbfounded by this offering. I knew the banks would push the envelope, but this is beyond description -- 100 basis points over a 5 yr. GoC for perpetual risk!!!!!!!!!!!!!!!! :roll: :roll: :roll:

There will be wailing in the streets at some point in time; it's just a matter of when.
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Re: Canadian preferred shares: Greedy or Fearful?

Post by Peculiar_Investor »

scomac wrote:I wouldn't necessarily be in any rush to sell just yet. With the appearance of this latest fixed/reset financing IPO, there could be some more upside to your preferred share if this new issue is well received. I'm dumbfounded by this offering. I knew the banks would push the envelope, but this is beyond description -- 100 basis points over a 5 yr. GoC for perpetual risk!!!!!!!!!!!!!!!! :roll: :roll: :roll:

There will be wailing in the streets at some point in time; it's just a matter of when.
I saw the BNS pref offer as well, but I didn't want to link James' full site. My feeling was if spreads were tightening that much, we're pretty well done. The spread on TD.PR.G is 438 bp as a comparison. I suspect that BNS has a grand strategy behind the offering that is for their benefit (and hopefully mine as a shareholder).

Getting back to the original question, what factors and math enters into your "I wouldn't necessarily be in any rush to sell just yet"?
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Re: Canadian preferred shares: Greedy or Fearful?

Post by scomac »

Peculiar_Investor wrote: Getting back to the original question, what factors and math enters into your "I wouldn't necessarily be in any rush to sell just yet"?
Just my gut. These things seem to sell on current yield with little consideration for calls. If they can make a sub 4% pref fly, then other rate reset prefs will continue to appreciate in price to the new level, call provisions be damned.

With respect to when to sell your existing TD pref:

TD Bank CORP 0.00 S 2014-04-02 86.63 3.62 M 3.93

The above is a TD bond with the closest maturity to your preferred share. That is wholesale pricing, but you can see that YTM is actually higher than YTW for your preferred so you aren't being compensated at all for assuming the perpetual risk no matter how remote that is, you are actually paying to take it on! :shock:
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