What are Preferred Shares?

Unfortunately I did not understand preferred shares completely before I invested in them.  As with many aspects of do it yourself investing, I learned more about what I invested in after accumulating experience with it.  As I read more about it, I become more cognizant that I was chasing yield and chasing dividends at the cost of growth.  Previously, I had a large percentage of my Questrade portfolio in CPD.TO (an exchange traded fund of multiple preferred shares), then a stop loss was triggered and I sold for a loss.  I will be able to file for capital loss for this.  I then proceeded to buy ZPR.TO (another exchange traded fund of multiple preferred shares, specifically, laddered), another preferred share and I currently have paper loss in this.  I hope to be correcting this soon and adjusting the percentage of my portfolio allocated to preferred shares namely reducing my exposure to preferred shares.

What are Preferred Shares?

Preferred shares are unique, they do have their upsides and they do have their downsides.

Preferred shares are a kind of mixed entity that has both fixed income and equity characteristics.  The main reason why I was drawn to them is because of the fixed distribution (for example, ZPR.TO pays about a high yield) and fixed income.  They are tax efficient as well, and are best kept in a non-registered portfolio.  Unlike bonds, the income from the yield is taxed like a Canadian dividend and given preferential tax rate.  Income from distribution from bonds are taxed at your marginal rate.

What are Preferred SharesThere are four different types of preferred shares:

  • Perpetuals
  • Rate Resets
  • Floating
  • Retractables

For more information on Canadian preferred shares, Bank of Montreal has a nice PDF explaining what the different types are and the benefits of preferred shares.

When interest rates fluctuate and drop, there is increased risk of volatility with preferred shares.  The Canadian Preferred Shares tanked while common stocks did well in the past year.  With the recent Bank of Canada announcement of decreased interest rate, my Canadian preferred shares took a large hit.  This Globe and Mail article explains what investors should know about the recent plunge in Canadian preferred shares.

What You Should Do if You Want Preferred Shares in Your Portfolio

If you do plan to include Canadian preferred shares in your portfolio, according to ETF guru, Canadian Couch Potato, there are a few things that you can do to limit your risk.

Limit the percentage allocation of Canadian preferred shares in your portfolio.  You should have a maximum of 5% to 10% of your portfolio to Canadian preferred shares.  For me, I was obviously chasing yield too much (aiming to increase my dividend income can backfire) and I estimate I have over 20% of my total portfolio in preferred shares.

Keep your preferred shares in a non-registered portfolio.  If you keep it in the TFSA or the RRSP, any tax advantage that you can get for capital loss is not available to you.  Thankfully I did this right, however, I do have a small portion of CPD shares in my TFSA (because I was OCD and liked to keep my ETF portfolios together).

Canadian Couch Potato also recommends not to buy individual preferred shares.  An exchange traded fund such as ZPR provides more diversification as it has coverage of over 140 different issues and has a low Management Expense Ratio of 0.45%.

Of course, all this depends on your time horizon, risk tolerance, your own situation (e.g. whether you need income versus growth and capital preservation), among other reasons.  For example, if you don't plan to need the money for a long time (think 10+ years) the recent paper loss in preferred shares shouldn't phase you.  On the other hand, if you are planning to use the money in the next 1-3 years, something that will be less risky is probably a better bet.

For further information on preferred shares, the Financial Post article on What Investors Need to Know about Preferred Shares is a good introduction to the risks associated with preferred shares.  Also, Finiki (the Financial Wiki for Canadians) has a great article on Canadian preferred shares as well.

Readers, do you have Canadian preferred shares in your portfolio?  If so, what has been your experience with it?  Personally, I think that I'll stick to basic low-cost index ETFs or putting money in super easy Wealthsimple account going forward.

6 Comments

  1. Barry @ Moneywehave on July 13, 2015 at 2:55 pm

    I still own CPD as I was attracted to the dividend payouts. I mistakenly assumed it was considered a “safe” investment due to those payouts but since I purchased the ETF, I’ve seen the value drop about 15%.

    I’m now debating selling at a loss and just sticking to investments I know more about.



  2. Will on July 19, 2015 at 10:58 pm

    It’s still wise to put CPD in reg account, coz I’m sure if all ETF yield can be considered as eligible dividend.



  3. Young on July 19, 2015 at 11:22 pm

    @Barry- We share the same pain Barry!



  4. Peter on July 23, 2015 at 9:39 pm

    I treat Preferred’s like I would treat any ETF’s. Sure, it’s down just like Bonds, but as long as I maintain my allocation, buying them up when they are low is not a bad thing and their dividend payout is still fixed.

    Unlike Couch Potato (who uber simplified his basic portfolio), I follow Garth Turner’s advice and have allocated 18% into Preferred (CPD and XTR), alongside with my other Fixed Income investment in Bonds (XBB). When times are good (not now), they will rise in price but still continue to throw monthly dividends.

    Sure, not everyone has the stomach to hold them but they are part and parcel of my monthly dividend yield (currently 180 dollars/month), alongside my REIT holdings.



  5. Kyle on July 23, 2015 at 10:11 pm

    Interesting approach Peter. I’ll have to read a little more from Mr. Turner on the topic.



  6. David on July 30, 2015 at 6:24 pm

    For a couple of good sources on preferred shares check out James Hymas’ website: www.prefblog.com/ or google ‘preferred shares report’. You’ll see reports from CIBC and Raymond James that are great resources on the preferred shares market.

    Preferreds have definitely taken a beating YTD but this only makes their valuations more attractive. I’d echo Peter’s sentiments above that preferreds are for income and should not be considered a growth component. My target is 15% of my portfolio.

    This market is heavily influenced by retail investors that have no idea what they are doing. People suddenly realized that all those fixed-resets are going to reduce their dividends after the BOC cut rates. The thing is, they’ll be resetting again in five years. If you think the overnight rate will be 0.5% or lower five years from now then don’t buy preferreds. I’m betting that won’t be the case.



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