# Is it time to use preferred shares for FI allocation?



## leoc2 (Dec 28, 2010)

Because of low returns on bonds and risk of interest rate hikes, is it time to start using high rated preferreds as a substitute for FI? Perhaps use CPD or XPF in place of XLB or XBB?


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## andrewf (Mar 1, 2010)

If you don't mind buying at the peak, then go for it!

Seriously, it is probably alright to allocate some part of your portfolio to preferreds, but I would limit it to 5 or 10% at most. Just look at the chart back to 2008 and realise that you are taking a lot more risk with preferreds than you are with long bonds.

If anything, you might consider shortening the duration of your bond holdings and adding to your equity exposure gradually. Why buy a TD preferred that has a yield to worst of 3% when you can buy the stock and get 4% with potential for growth.


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## kcowan (Jul 1, 2010)

I read a study that showed the stock to yield about 2% more than their preferred over a ten year period for the bank banks. I think you should consider PFSs to be equity. Their market value is less volatile but it is still volatile!


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## OptsyEagle (Nov 29, 2009)

That was the same argument many investors used to justify buying income trusts with their fixed income allocation, 5 years ago. When they dropped 30% to 60% during the Halloween massacre and more destructively during the credit crisis, they were quickly introduced to the error in that strategy.


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## leoc2 (Dec 28, 2010)

OptsyEagle said:


> That was the same argument many investors used to justify buying income trusts with their fixed income allocation, 5 years ago. When they dropped 30% to 60% during the Halloween massacre and more destructively during the credit crisis, they were quickly introduced to the error in that strategy.


With a 30 year winning record I guess I am worried that it is time to massacre bonds. What else qualifies as Fixed income?


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## kcowan (Jul 1, 2010)

leoc2 said:


> What else qualifies as Fixed income?


GICs and HISAs are the only true FIs. Convertibles, Prefs and even bonds themselves do not offer equity protection. Yes bonds held to maturity do. But not bond funds/ETFs.


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## OptsyEagle (Nov 29, 2009)

leoc2 said:


> With a 30 year winning record I guess I am worried that it is time to massacre bonds. What else qualifies as Fixed income?


Hey, no one said you need to hold bonds. I have never owned one. All I like to see is that an investor understands exactly what they do own. Having 60% in stocks, 20% in preferreds and 20% in income trusts is not going to protect your portfolio anymore then have 100% in stocks.


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## leoc2 (Dec 28, 2010)

What do you think about the RBC Target Maturity Corporate Bond ETFs?


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## Jon_Snow (May 20, 2009)

Garth Turner is a big proponent of Canadian big bank preferreds as an intregal part of one's fixed income portfolio... I've been thinking about it myself lately.


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## leoc2 (Dec 28, 2010)

kcowan said:


> GICs and HISAs are the only true FIs. Convertibles, Prefs and even bonds themselves do not offer equity protection. Yes bonds held to maturity do. But not bond funds/ETFs.


From 
Bonds vs. Bond Funds? An Easy Choice!
The argument that holding a bond to maturity eliminates interest rate risk is completely false. Holding onto the bond has an opportunity cost! See link for calculation.


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## HaroldCrump (Jun 10, 2009)

leoc2 said:


> The argument that holding a bond to maturity eliminates interest rate risk is completely false. Holding onto the bond has an opportunity cost! See link for calculation.


While that is true, it ignores one of the primary reasons for holding bonds - to meet a known future liability in a guaranteed and predictable manner.
That future liability is often retirement, funding kids' education, etc.
The amount is often known (more or less) and the discount rate is known (more or less).
Bonds enable you to do that while bond funds not as accurately.

Also, the bid/ask spread that the author is complaining about is getting tighter these days with discount brokerages and with no spread, commissioned bond trading by brokerages such as Scotia iTrade.
Whereas, the MER on bond funds/ETFs year over year will cost the investor a lot more than the bid/ask spread if they do need to sell a bond once in a few years.

Bond ETFs may provide quick and easy asset allocation, but when it comes to meeting a known future liability, individual bonds are still the most reliable, IMHO.


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## kcowan (Jul 1, 2010)

It is only "mark to market" rules that create confusion on bonds. Now that trading bond ETFs is common, even bonds can no longer be considered true FI.


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## Square Root (Jan 30, 2010)

kcowan said:


> I read a study that showed the stock to yield about 2% more than their preferred over a ten year period for the bank banks. I think you should consider PFSs to be equity. Their market value is less volatile but it is still volatile!


Agree. Would pick common over prefs for the banks. especially when the commons yield is so high. You really only need about 4% cap appreciation to be ahead on the commons. Also people often forget the reinvestment risk if the prefs are called or mature.


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## kcowan (Jul 1, 2010)

Square Root said:


> Also people often forget the reinvestment risk if the prefs are called or mature.


Yes the whole YTM issue. Also your coupon is fixed and the common dividend will usually increase over a five-year term.


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