This Week: CLAYMORE S&P/TSX CDN PFD-COM Ticker: CPD / TSX

Pity the equity mar­kets. Over the last sev­eral weeks, in fits and starts, they have shown signs of cau­tious strength in response to signs of eco­nomic growth and new pro-growth poli­cies in sev­eral major mar­kets. But each time, they have been knocked flat by another wave of nau­se­at­ing pol­i­tics. This strug­gle between oppor­tu­nity and risk poses chal­lenges for investors.

For many investors, the instinc­tive response is to run for the safety of bonds, espe­cially long-tenured gov­ern­ment trea­suries, (assum­ing the sov­er­eign is sol­vent). As prof­itable as that trade has been this year, it would be a mis­take to stay with it now.

An exchange-traded fund of long gov­ern­ment bonds, iShares XLB/TSX, has returned in total 16.5% in the year to date. Most of that has come from cap­i­tal gains, as demand from safety-seeking investors has pushed prices higher, leav­ing yields razor thin.

How­ever, the only thing keep­ing bond yields from ris­ing (and prices from falling) is the fear that the Euro cur­rency will dis­in­te­grate and plunge Europe into a reces­sion. True, the Euro­peans have been incred­i­bly inept in deal­ing with their self-inflicted cri­sis. But dis­in­te­gra­tion is an extreme scenario.

More likely, the Euro­peans will mud­dle through, much like the U.S. Con­gress did with its one-minute-to-midnight debt ceil­ing show­down last sum­mer. Last week’s Euro­pean Union pro­posal for tougher, har­mo­nized finan­cial reg­u­la­tions and stricter pan-Euro fis­cal poli­cies was a step in the right direc­tion. Progress on this plan will send bond prices tum­bling as investors rush back to equities.

Even­tu­ally, eco­nomic fun­da­men­tals will reassert them­selves: high cor­po­rate prof­its, pos­i­tive indus­trial growth, lower unem­ploy­ment and improved con­sumer sen­ti­ment in the United States; lower infla­tion and a tran­si­tion to eas­ier, expan­sion­ary money poli­cies in Brazil, Aus­tralia, India and most sig­nif­i­cant of all, China, the world’s second-largest econ­omy. Then per­haps, equi­ties will finally shake off their dismay.

Until then though, investors’ manic depres­sive behav­iour will con­tinue. There is no cure for it, but to con­trol the symp­toms, investors could con­sider pre­ferred shares, that class of secu­rity that exists some­where between bonds and equi­ties. Pre­ferred shares offer the poten­tial of some cap­i­tal gains when equi­ties rise while par­tially pro­tect­ing against setbacks.

There are a few exchange-traded funds hold­ing Cana­dian pre­ferred shares. The old­est and biggest is Claymore’s CPD/TSX.

Com­par­ing CPD to an ETF of qual­ity cor­po­rate bonds like iShares’ XCB/TSX shows that CPD actu­ally has a lower volatil­ity of about 4.3% annu­al­ized ver­sus 10.5% for XCB and 16.5% for iShares S&P/TSX Com­pos­ite (XIC/TSX) ETF. Where the bond ETF is neg­a­tively cor­re­lated to the Com­pos­ite (one zigs, the other zags), the pre­ferred ETF has a low but pos­i­tive cor­re­la­tion (one zigs, the other usu­ally zigs too but not by as much).

On returns, the bond ETF is the clear win­ner this year with a total return of 7.1% while CPD has returned 3.9%. But this trend should revert to its longer-term mean. Over the past three years, CPD has returned about 14%, out­pac­ing XCB by about 4%. On top of that add the advan­tage of CPD’s div­i­dend tax credit.

CPD holds about 150 dif­fer­ent pre­ferred share issues, though unique issuers num­ber about 32. Brook­field and the big five banks make up half the hold­ings by weight. All the hold­ings are of high credit qual­ity, sim­i­lar to the bond ETF.

One other ETF of pre­ferreds is Hori­zons’ HPR/TSX. It is just a year old with a much smaller asset base but what sets it apart is its active man­age­ment style. The pre­ferred share mar­ket is nei­ther broad nor deep. Rel­a­tively few issuers and illiq­uid trad­ing leaves bid/ask spreads wider than in, say, com­mon shares. To cor­rect for this, HPR uses some dis­cre­tion in decid­ing what and when to buy. CPD, on the other hand, sticks close to its bench­mark index.

HPR’s year-to-date is 5.3% or 1.3% more than CPD, though some of that dif­fer­ence comes from HPR’s hold­ings of some U.S. pre­ferreds from issuers like Amer­i­can Express and Gen­eral Elec­tric. Quality-wise, its hold­ings are com­pa­ra­ble to CPD’s though of course, div­i­dends on the U.S. hold­ings do not receive pref­er­en­tial tax treatment.

Both ETFs how­ever are decent anti­dotes for the queasy few months ahead.

The archerETF Global Tac­ti­cal Portfolio

archerETF offers Global Tac­ti­cal Port­fo­lio Management.

Our out­look is Global: we invest across coun­tries, sec­tors, com­modi­ties and other asset classes to improve returns. Our man­age­ment is Tac­ti­cal: we strive to select the right oppor­tu­ni­ties at the right times in response to chang­ing mar­ket con­di­tions to man­age and min­i­mize port­fo­lio risk.

Please call us at TF 1–866-469‑7990 for more information.

Vikash Jain, Vice President, Portfolio Management, and regular guest on BNN, brings over 15 years of experience in investment management to archerETF, with the majority of his career devoted to portfolio management. Prior to founding archerETF in 2008, Vikash spent 6 years with Northwater Capital, an institutional manager, where he managed $5 billion in structured portfolios including a $1.5 billion fund of equity futures and swaps overlaid with hedge funds. Read more from the author/contributor here.

Comments

Comments are closed.