Clark Wealth Management Group - ScotiaMcLeod Fredericton

With interest rates at sub-terrain levels and equity markets as volatile as they are, income oriented investors are compelled to accept very low returns. For those investors with a low to moderate risk tolerance, an alternative they should be exploring is dividend producing preferred shares.

Although technically they’re a form of equity, the easiest way to think of preferred shares is that they look similar to, and often behave like bonds. Like equity, a preferred share is an ownership interest in a company, but like a bond it has a face value and produces a pre-set distribution (dividend) to its holder. Unlike a bond however, dividends paid on preferred shares can be suspended or reduced without it putting the issuer in default.

It’s important to note that preferred shares are junior to all the issuers debt so interest payments take priority. Also, if an issuers assets were liquidated, bondholders would get paid first.

Preferred shares can be well suited to relatively conservative investors – particularly in non-RRSP accounts where taxation is a consideration. Preferred shares are especially attractive because they offer a relatively high yield, because they are relatively safe and because they relatively are liquid. Most preferred issues are listed on major stock exchanges, making them easy to buy and sell. Finally, preferred shares rank senior to common shares meaning that a preferred shareholders claims to dividend and assets of the issuer come before common shareholders’ claims.

The stability of the issuer, as with bonds, is determined by independent rating agencies like Standard and Poors who rate many preferred issues from the highest quality (P-1 or PFD-1) to speculative (P-5 or PFD-5). Ratings are an indication of the stability of the issuers, not a guarantee of payment.

There are several different types of preferred shares. Assuming the same stability ratings of the issuer, “hard retractable” preferred shares are the most conservative. The most commonly issued type of preferred shares these days are “five-year rate reset perpetuals”. These are issued with no ultimate maturity date (perpetual) but there are times through the life of the investment (eg. every five years) when interest rates will be reset to reflect the then current interest rate environment.

From a tax perspective, one of the major advantages of investing in preferred shares is the dividend tax credit. This credit significantly eases the burden of receiving investment income when compared to interest income. Essentially, all dividends collected on Canadian companies are eligible for this tax credit. With this in mind, quite often preferred issues are a great alternative for producing income when compared to other interest bearing investments (e.g. GICs and bonds) which are fully taxed.

If you think preferred shares may have a place in your portfolio, check with your advisor. Because of all the complexities associated with these “hybrid” investments, expert advice is essential to choose both the right type of preferred security and the right issue.

Keir Clark, is a senior wealth advisor, with Clark Wealth Management Group, associate director wealth management and branch manager at ScotiaMcLeod in Fredericton, NB. He can be reached online at www.keirclark.ca or by telephone at 506-450-6465.

Information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, expressed or implied, is made as to the accuracy or completeness.