I often have people ask me whether they should include preferred shares in their portfolio and although I am not a great fan of this investment product, I have many peers who use them exclusively in their client’s portfolios. So, today let’s talk about all the different types that are available and you can see for yourself if this is an investment style you would like to entertain.
What are they? Preferred shares are corporate shares that are not classified as common or restricted. Preferred shares usually receive a fixed dividend payment and are considered to have part ownership like common shareholders; however, they have a higher ranking than common shares as a claim on the asset. Preferred shares are bought largely by income-oriented investors to take advantage of dividend tax credits. There are several different options when choosing this investment. Here are the most popular.
- Straight Preferred: Pay a fixed dividend rate and the shares can be traded in the market on a yield basis.You will receive a dividend tax credit but will have no voting privileges.
- Convertible Preferred: Similar to convertible bonds to enable the investor to convert the preferred into common shares at a predetermined price, during a stated, predetermined time period.
- Retractable Preferred: Similar to retractable bonds to force the company to buy back your preferred shares for cash on a specified date and at a specified price if you want to exercise this right.
- Floating Rate Preferred: This is a variable rate preferred that pays dividends in amounts that fluctuate with current interest rates.
- Foreign Preferred: Most Canadian preferreds pay dividends in Canadian funds, however foreign preferreds payout in foreign currency creating additional risk based on the value of the Canadian or US dollar.
- Deferred Preferred: This product does not receive a regular dividend like the others. Instead, the shares mature at a pre-set future date and the return is based on the purchase price minus the redemption value paid at maturity. This type of investment is the best one to be used with RRSPs because of the compounded growth and the deferred tax feature. I mainly used this type for my clients in the past, since if the shares were sold prior to redemption, the income would be treated as a capital gain or capital loss. Also, these shares allow you to defer taxes paid on income earned and are more attractive to an investor who does not have an immediate need for regular income.
Remember that preferred shares follow the current interest rates since they are considered a fixed income product. If the interest rates rise, the dividend payment becomes less valuable, and the marketable price of your investment will fall. If on the other hand the interest rates decline, the fixed dividend becomes more valuable on the preferred product and the market price will go up.
If you want to invest in preferred shares or simply want to diversify your portfolio and provide another tax incentive, make sure you choose an advisor that is well versed in this market. Not all investment advisors know how to properly navigate with preferred products, and it is not for the faint of heart. You should deal with a large brokerage firm/dealer and choose an advisor that has been working with preferred shares through different market environments.
Do your homework. They are a good investment to be considered.
Good Luck & Best Wishes,
ATML - Christine Ibbotson