All preferred shares are not created equal.
Rate reset preferred shares offer an attractive alternative.
by Stephane Ruah, Richardson GMP Limited
I am often asked by clients to explain the difference between the various preferred shares available in the marketplace. There are so many types of products available, each with special features that investors should know about as they are investing their hard earned money.
In this article, we will demystify rate reset preferred shares: what are they and how they can help build a well-diversified portfolio.
What are rate reset preferred shares?
A typical preferred share will pay a fixed dividend in perpetuity, while rate reset preferred shares will pay a fixed dividend for a specific predetermined time, usually five years, then recalibrate. At the reset date, provided the issuer does not call the preferred share for the issue price, investors can elect to either take the Government of Canada 5-year rate plus a fixed spread, or opt for a floating rate that offers the 3-month T-bill yield plus a spread.
For example, company ABC issues a preferred at $25 that pays 5% with a reset clause of 2.5%. This means that in five years, on the anniversary of the initial date established, ABC can recall it at $25. Alternatively, ABC may choose to roll it out for an additional period of time, usually five years, and reset the new rate to the five-year Government of Canada bond yield plus the reset clause. If the five-year yields are 3%, the new rate for company ABC will be 3% + 2.5%, or 5.5%.
These shares are attractive to investors as they offer a tax advantage over buying bonds. Although the dividends are fixed, as with a bond coupon, they are taxed at a preferential rate over interest payments, leaving you with more money in your pocket.
When considering reset preferred shares, it is important to keep in mind that they are not guaranteed like a GIC. If the issuer experiences poor business conditions leading to financial difficulty, preferred shares can significantly erode in value and even become worthless. Therefore, it is important to invest in solid companies with a consistent track record of paying dividends, especially in turbulent economic times.
Today, interest rates are at historic lows with rates on cash and cash equivalents being less than the rate of inflation. In this type of environment, rate reset preferred shares offer a very good alternative as resets have the potential to increase their dividends as rates rise.
Do you have questions about rate reset preferred shares or other fixed income investment solutions? Please feel free to contact me directly.
Stephane Ruah is Director, Wealth Management and Investment Advisor at Richardson GMP Limited, Canada’s largest independent wealth management firm. He provides exclusive and innovative investment services to successful families and entrepreneurs and can be reached at 514.288.4018 or Stephane.Ruah@RichardsonGMP.com and you may subscribe to our free bi-weekly newsletter at http://www.thermgroup.ca.
The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.
