It’s not easy for income-seeking investors to find attractive yield in today’s slow growth economic environment. Pat Chiefalo says preferred shares may offer a solution to their problem.
Preferred shares were hit hard by the dramatic fall in oil prices that forced the Bank of Canada to cut its key lending rate twice in 2015, but we think conditions are ripe for income-oriented investors to reconsider this segment of the equity market for the following three reasons:
1. Stable interest rates
We expect preferred shares to benefit from a period of stable interest rates ahead. Expectations of additional easing by the Bank of Canada have been reduced in recent months by the rebound in oil prices, which has quelled recession fears, but also by growing concerns that already buoyant real estate markets in Toronto and Vancouver could overheat if interest rates were cut any further.
2. Attractive yields
Yields on preferred shares have climbed in the past year and a half, making them potentially more attractive to income-starved investors who want to diversify their holdings beyond traditional government bonds and GICs.
The iShares S&P/TSX Canadian Preferred Share Index ETF (CPD), for example, now provides a dividend yield over 5% which is equivalent to a bond yield of ~7% (since dividends are taxed at a lower tax rate than interest income). This contrasts with the current 10-year Government of Canada bond yield that is just above 1%.
3. More demand than supply
As yields on preferred shares rose over the past year and a half, many corporate issuers turned to debt markets as a cheaper source of financing for their funding needs. This lack of supply has coincided with strong demand – including among institutional investors who purchased large amounts of the Canadian bank’s last round of attractively-priced preferred share issuance in December.
With the strong earnings reported by the banks this past quarter, we suspect issuance of prefs in the financials sector may increase in the weeks ahead. This would potentially put some price pressure on the preferred share market in the short-term, but any pullbacks could represent opportunity to source higher yields.
Investors who agree that conditions have turned more favourable for preferred shares, may want to consider the aforementioned iShares S&P/TSX Canadian Preferred Share Index ETF (CPD). Not only does it offer an attractive yield, it also provides exposure to a diversified portfolio of over 200 Canadian preferred shares and offers regular monthly dividend income.
Pat Chiefalo is a managing director and head of iShares Canadian Product for BlackRock Canada.
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