# Canadian Preferred Share ETF



## Dilbert (Nov 20, 2016)

Garth's blog has been promoting that a savvy investor should have some with a rate reset feature. Anyone have any thoughts or experience to share?


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## AltaRed (Jun 8, 2009)

Dilbert said:


> Garth's blog has been promoting that a savvy investor should have some. Anyone here have any thoughts or experience?


They are, in my opinion, a sub-class of equity, or if you wish, bonds on a roller coaster. You have to be a savvy investor to buy when they are bloodied in the streets to make the risk worthwhile. IOW, buy then when they are discounted well below their $25 par value so that one can capture both the eligible dividend yield PLUS cap gains potential to make them worthwhile. In the case of Fixed Resets which have been the theme of the day for about 5 years now, one can lose their shirt buying these things anywhere close to par because there is mostly only cap loss potential, not cap gains. OR, buy the Fixed Resets that have a yield floor (most of the ones issued in the last two years) in which case, cap loss is likely capped... but they will likely be called by the issuer in 5 years time (in which case consider them 5 year money with enhanced yield).

The original primary class of prefs are the old standard perpetuals which have a fixed yield until called by the issuer... which might be never. They are more like a long term bond with no maturity date. 

Always put prefs into a taxable account where they are most tax efficient (eligible dividends).

Most investors don't have the skill/acumen to buy individual prefs in which case ETFs like CPD and ZPR are the 'go to' products. Personally, I think Garth is simply another blogger who is stating the obvious after the horse is leaving the barn. I don't think many investors should have prefs in their portfolios. For those with large portfolios and/or nowhere to put enough interest bearing securities into their registered accounts, prefs are worth looking at.


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## james4beach (Nov 15, 2012)

I wouldn't buy them unless you understand them and are convinced that they offer you something vital that stocks or bonds don't offer. They are complex instruments and the market has poor liquidity. Buying them with a fund alleviates some of those problems, but you still fundamentally should understand what you're buying, and those liquidity problems don't go away just because they're inside a fund.

ETFs are not a natural fit for instruments that have poor liquidity. The way an ETF works, could force the fund to sell the preferred shares are steep discounts in an illiquid market.

The ETFs carry high fees, 0.51% on CPD and 0.50% on ZPR. This is dramatically higher than the fees you'll pay on either a stock or bond ETF.

For reference, CPD performance is about 0% and ZPR about -4% annual return since inception (those figures are to end of November; check the ETF provider web sites in a couple days to see performance up to end of year)


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## Dilbert (Nov 20, 2016)

Thanks for the information folks. Me thinks I will stick with regular shares as they have been good for me. I don't think I am sophisticated enough to handle the prefs. 

Appreciate the quick and helpful comments!


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## andrewf (Mar 1, 2010)

james4beach said:


> I wouldn't buy them unless you understand them and are convinced that they offer you something vital that stocks or bonds don't offer. They are complex instruments and the market has poor liquidity. Buying them with a fund alleviates some of those problems, but you still fundamentally should understand what you're buying, and those liquidity problems don't go away just because they're inside a fund.
> 
> ETFs are not a natural fit for instruments that have poor liquidity. The way an ETF works, could force the fund to sell the preferred shares are steep discounts in an illiquid market.
> 
> ...


ETFs can make trading in illiquid instruments easier, as the ETF itself tends to be more liquid than the underlying.


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## james4beach (Nov 15, 2012)

That's true, and the shares of the ETF are going to be liquid. But this can also mask the fact that the underlying market carries liquidity risks with it. Say for example that investors pulled $100 million out of ZPR. This would force ZPR to liquidate the underlying, and in a market with poor liquidity, they will realize losses when they're forced to trade with wide bid/ask spreads of the actual preferred shares. _All_ investors in the fund then lose due to the poor liquidity.


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## AltaRed (Jun 8, 2009)

Assuming the market maker actually markets the underlying prefs at the time ETF units are sold. That is not necessarily the case in 'crisis' times, or in the short term, if the market maker actually holds the units temporarily rather than 'destroying' them. As I understand it, there is a lot of complexity behind the market maker.


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## Saniokca (Sep 5, 2009)

Dilbert said:


> Garth's blog has been promoting that a savvy investor should have some with a rate reset feature. Anyone have any thoughts or experience to share?


After understanding how rate-resets work I've purchased quite a bit of them in 2016 (5 individual companies, not an ETF). They've returned between 25-50% since I bought them (somewhere in Q1-Q2). Basically my main bet was/is that rates will increase and I will get some capital gains before they are ever called. Meanwhile I would be collecting a 5% dividend - not too bad.

I agree with some other comments:
- If you don't understand them - stay away (this is true about anything really).
- I wouldn't buy them anywhere near par value - there is no upside. But buying at a steep discount when rates are very low (they were even lower when I started buying them) makes sense in my opinion.
- Liquidity is an issue so unless you're willing to hold for a long time I'd be careful.
- put prefs into a taxable account - unless you have TFSA/RRSP/RESP room.

Note of caution - lately two stories popped up about the resets:
*RONA*
http://business.financialpost.com/n...n-why-24-a-share-is-more-fair-than-25-a-share

and 

*TransAlta*
http://business.financialpost.com/n...s-the-grinch-with-its-preferred-share-holders


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## tojo (Apr 20, 2009)

Saniokca said:


> After understanding how rate-resets work I've purchased quite a bit of them in 2016 (5 individual companies, not an ETF). They've returned between 25-50% since I bought them (somewhere in Q1-Q2). Basically my main bet was/is that rates will increase and I will get some capital gains before they are ever called. Meanwhile I would be collecting a 5% dividend - not too bad.
> 
> I agree with some other comments:
> - If you don't understand them - stay away (this is true about anything really).
> ...


I bought them in 2015/early 2016 and seeing excellent gains as well. That said, the majority of the gains have been due to narrowing credit spreads. There is another leg up if / when interest rates normalize. You are seeing some of it now as the Government 5 bond is creeping up. Many shares are still well below par. I've done much better than ZPR/CPD but only buy individual shares if you understand how these things work.


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## mordko (Jan 23, 2016)

If anyone were to go with a Pref ETF, HPR is worth a look. The extra cost vs ZPR is small. In my opinion active management is worth paying for in a category which requires very careful reading of T&Cs and has a lot of obvious junk. Indeed, HPR outperforms ZPR. 

Having said this, the whole idea of Prefs is rotten - the downside risk is all yours but on the way up you hit the ceiling. Like others have said, they are only worth buying at a huge discount. Even then... How are they diversifying your stocks if they usually tank more than XIC does and at the very same time?


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## mordko (Jan 23, 2016)

<Disclosure> I bought a few K in HPR a year ago and did make some money but got rid of it in December.


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## AltaRed (Jun 8, 2009)

mordko said:


> Having said this, the whole idea of Prefs is rotten - the downside risk is all yours but on the way up you hit the ceiling. Like others have said, they are only worth buying at a huge discount. Even then... How are they diversifying your stocks if they usually tank more than XIC does and at the very same time?


Whether they tank at the same time as stocks depends on where bond yields are going at the same time. I've never compared performance but for accredited investors, there is alway James Hymas' MAPF (Malachite Aggressive Preferred Fund) http://www.himivest.com/malachite/MAPFMain.php Pretty sure he beats the competition (on a multi-year basis at least)


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## like_to_retire (Oct 9, 2016)

mordko said:


> Having said this, the whole idea of Prefs is rotten - the downside risk is all yours but on the way up you hit the ceiling. Like others have said, they are only worth buying at a huge discount. Even then... How are they diversifying your stocks if they usually tank more than XIC does and at the very same time?


You're really over-generalizing pref shares and lumping all types together. Every type responds differently depending on market conditions and can be purchased to solve different needs.

A retiree that had no room left for fixed income in registered accounts, and didn't like the highly taxed and low yield of bonds, might accept some extra credit risk and purchase a high spread, minimum floor fixed reset pref at 4%-5% tax advantaged yield for 5 years, at which time they would accept the call.

Or, if they didn't care much about share price and wanted income at a 5% yield that lasted forever, Ithey might buy a discount straight perpetual pref share in a non registered account.

I don't consider these two examples (and I can come up with many more) that are basically allocations to fixed income as _rotten_ and certainly have little to do with an equity allocation to XIC.

ltr


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## mordko (Jan 23, 2016)

AltaRed said:


> Whether they tank at the same time as stocks depends on where bond yields are going at the same time.


That's true but what will bond yields do after a stockmarket crash?


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## AltaRed (Jun 8, 2009)

mordko said:


> That's true but what will bond yields do after a stockmarket crash?


Usually fall too.... but not guaranteed. The distinction is important if not the result.


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## ja2345 (Jan 1, 2017)

james4beach said:


> I wouldn't buy them unless you understand them and are convinced that they offer you something vital that stocks or bonds don't offer. They are complex instruments and the market has poor liquidity. Buying them with a fund alleviates some of those problems, but you still fundamentally should understand what you're buying, and those liquidity problems don't go away just because they're inside a fund.
> 
> ETFs are not a natural fit for instruments that have poor liquidity. The way an ETF works, could force the fund to sell the preferred shares are steep discounts in an illiquid market.
> 
> ...



Apologies in advance - this is somewhat off topic and might have already been covered elsewhere on this blog (I'm a new member). You mention that the preferred ETFs carry high fees. I have a more general question about whether, in addition to the disclosed MER, there are any other costs (hidden or otherwise) of ETFs that impact the total return?


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## Dilbert (Nov 20, 2016)

ja2345 said:


> Apologies in advance - this is somewhat off topic and might have already been covered elsewhere on this blog (I'm a new member). You mention that the preferred ETFs carry high fees. I have a more general question about whether, in addition to the disclosed MER, there are any other costs (hidden or otherwise) of ETFs that impact the total return?


Great question! I've been wondering the same thing myself about ETF's in general.


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## AltaRed (Jun 8, 2009)

ja2345 said:


> Apologies in advance - this is somewhat off topic and might have already been covered elsewhere on this blog (I'm a new member). You mention that the preferred ETFs carry high fees. I have a more general question about whether, in addition to the disclosed MER, there are any other costs (hidden or otherwise) of ETFs that impact the total return?


No. What you see posted is what you get when it comes to performance returns. 

FWIW, I agree the MERs are high relative to bond and most equty ETFs (boutique ETFs excepted) albeit a Pref ETF is indeed also a boutique ETF. Boutique ETFs slice and dice a narrow segment of the broader market and thus incur more complexity and difficulty in managing the holdings of the ETF (never mind potential liquidity issues underlying specific holdings). I've never been a fan of boutique ETFs. They are a nemesis to the original purpose of ETFs which was to cover broad based markets based on easily recognizeable indices.


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## doctrine (Sep 30, 2011)

Rate reset preferred shares are potentially a fantastic way to offset long term bonds. I think they're a buy at current levels, although perhaps not for much higher as they've recovered fairly well.


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## mordko (Jan 23, 2016)

ja2345 said:


> Apologies in advance - this is somewhat off topic and might have already been covered elsewhere on this blog (I'm a new member). You mention that the preferred ETFs carry high fees. I have a more general question about whether, in addition to the disclosed MER, there are any other costs (hidden or otherwise) of ETFs that impact the total return?


The only other expense relates to trading costs, which are covered in TER but not MER. There is little trading for vanilla index-based ETFs, so you don't need to worry about TER. If you are into "boutique" or active ETFs then trading costs could become important.


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## james4beach (Nov 15, 2012)

The total return performance that's quoted is the all-in performance.

There are more "expenses" than just the MER though. As mentioned by mordko there is the trading expenses. Additionally when illiquid securities are involved, there are losses seen due to bid/ask spreads in the underlying (same goes for corp bond ETFs). All of those things drag the performance down, slightly, but in the end the performance figure that's published is accurate and all-in.


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