# Preferred Shares Necessity for Portfolio?



## PuckiTwo (Oct 26, 2011)

I appreciate your comments on the following:

We want to increase diversification in our portfolio which we recently moved to TDW for DIY and are looking at Preferred Shares. It was mentioned in other threads - a complex issue. For example, we need to increase the financial sector, so I looked at a new issue pref bank shares but find them fairly unattractive with relatively low dividends.

What I got from James Hymas’ Prefblog is that especially the “rate-reset ones will be redeemed at their earliest possibility” due to the implementation of Basel III, an international set of rules to ensure banks have enough capital which will take place in Canada after Jan 1, 2013. Basel III applies only to bank stocks. It’s very complicated and I don’t understand a lot of it but it does not sound like something I want to invest in at the moment.

My major question to the Forum: are Pref Shares a necessity, a must-have in a balanced retirement portfolio? Do most of you own pref shares? 

Our asset allocation is presently 58% equities, 31% fixed income (bonds and ETFs), rest is cash and other. I would like to get the equities up to 63-65%, keep the fixed income at that present level. 

Thanks for your help, Puckie


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## leoc2 (Dec 28, 2010)

Here is some info on preferred shares:
http://www.finiki.org/wiki/Preferred_Shares

I don't own any in my retirement portfolio.


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## GoldStone (Mar 6, 2011)

In my opinion, they are NOT a necessity or a must-have. I don't own any.

This quote from Finiki explains their primary role in a portfolio:



> An individual's Investment Policy Statement will call for a percentage of the portfolio to be held in fixed-income securities. Usually, this entails holding a mix of government and corporate bonds within a tax-sheltered account, such as a Registered Retirement Savings Plan, Registered Retirement Income Fund, Locked In Accounts or Tax-Free Savings Account. If earned in a taxable account, bond income will be taxed at an individual's marginal tax rate for ordinary income[9]. *Some individuals do not have sufficient room within their registered accounts for their fixed-income allocation and must elect either to pay tax at full marginal rates on their bond income or to purchase preferred shares, which pay tax at lower marginal rates because of dividend tax credits*[10].


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## Sampson (Apr 3, 2009)

Equity risk without offsetting potential reward. The debt crisis showed that the 'preferred' is meaningless. Only debt holders will get money if a company is in trouble.

ONLY if you want income (as described above) would I consider them, but even then, the gap in the payout in a regular vs. preferred share is often smaller than one would like if there is no opportunity for capital growth.


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## Canuck (Mar 13, 2012)

I don't own any preferred shares, not necessary


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## PuckiTwo (Oct 26, 2011)

*Leoc2, Goldstone, Sampson:* Thks a lot for sharing your knowledge. 

I think that's settles it for me - no preferred shares, at least not now. Thks for the finiki.org link which also says at one point "that the product is better bought through a professional due to its complexity"... The idea of adding specific preferred shares actually came from our former financial advisor, the one we have gotten rid of, and I wanted to make certain that I didn't miss an important portfolio component. I looked at Hymas' information and searched this forum before I posted and got the idea that there don't seem too many posters who own preferred shares but I could be mistaken. Thanks again!


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## Cal (Jun 17, 2009)

Have you considered XPF? It offers simplicity and preferred share exposure. I don't own it, but thought it may be of interest to you.


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## GoldStone (Mar 6, 2011)

CPD is more popular than XPF, by far. Assets under management: 1.27B vs 159M.

Pucki:

Many retired posters over at FWF own preferred shares. Prefs are very useful if you need to hold fixed income in a taxable account. This usually happens in retirement when older folks reduce their equity allocation. The crowd here on CMF is quite a bit younger. Prefs are less useful when you accumulate assets.


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## kcowan (Jul 1, 2010)

I am retired and I have 5% of my portfolio in a Pref fund. Because it has performed well, I am considering increasing it to 10%. But I agree that as a younger investor, it is not necessary.


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## PuckiTwo (Oct 26, 2011)

GoldStone said:


> 1. CPD is more popular than XPF, by far. Assets under management: 1.27B vs 159M.
> 2. Prefs are very useful if you need to hold fixed income in a taxable account. This usually happens in retirement when older folks reduce their equity allocation. The crowd here on CMF is quite a bit younger. Prefs are less useful when you accumulate assets.


1. *Goldstone / Cal:* I will study both. Thks.
2. I should explain that I don't need increase fixed income in a taxable account, I have room again in my RRSP due to a matured bond and at present, although retired, I don't want to reduce my equity allocation. By the way, in regards to the "younger crowd on CMF": nothing wrong with learning from younger people who often have a much more forwarding looking approach (....not always). But I see your point. What's important to me to learn from the responses that I don't have to be in a tearing rush to get preferreds. Thks a lot for your points.



kcowan said:


> I am retired and I have 5% of my portfolio in a Pref fund. Because it has performed well, I am considering increasing it to 10%. But I agree that as a younger investor, it is not necessary.


*Kcowan:* Thks, that gives me some kind of an idea how much allocation for preferreds. You mention in another preferred shares thread that you are with Hymas and looked at his site. Minimum is 50k for his fund and I did not want to invest more than 10-15k. He is probably not interested or his co. could be too expensive for me.


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## Nemo2 (Mar 1, 2012)

PuckiTwo said:


> Minimum is 50k for his fund


And that, IIRC, is if one is designated as an 'Accredited Investor'...otherwise it's $150K


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## My Own Advisor (Sep 24, 2012)

I also don't own any preferred shares. Own dividend paying stocks and broad market ETFs.


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## pwm (Jan 19, 2012)

I like Pref Shares myself. I have 18% of my total investments in Prefs. I'm retired and consider them to be the fixed income component in my investment account. I don't like bond funds because of the low yield, high MER and prefs qualify for the dividend tax credit.


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## leoc2 (Dec 28, 2010)

pwm said:


> I like Pref Shares myself. I have 18% of my total investments in Prefs. I'm retired and consider them to be the fixed income component in my investment account. I don't like bond funds because of the low yield, high MER and prefs qualify for the dividend tax credit.


Preferred shares behave more like stocks than bonds in a crisis. Asset allocation is supposed to create an acceptable risk level for your portfolio. The bonds are suppose to stabilize the overall portfolio volatility. You may regret the risk you are taking with preferred shares in a financial crisis.


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## PuckiTwo (Oct 26, 2011)

pwm said:


> I like Pref Shares myself. I have 18% of my total investments in Prefs. I'm retired and consider them to be the fixed income component in my investment account. I don't like bond funds because of the low yield, high MER and prefs qualify for the dividend tax credit.


PWM, would you mind sharing in which companies you own preferred shares?


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## james4beach (Nov 15, 2012)

PuckiTwo said:


> ﻿My major question to the Forum: are Pref Shares a necessity, a must-have in a balanced retirement portfolio? Do most of you own pref shares?


No, they're not a necessity. I don't own any.

They are complex, tricky, and *illiquid*. Already that fails several of my criteria for an investment. There are enough plain vanilla stocks and bonds to keep you busy, and I'd rather deal with instruments that are liquid and not tricky-by-nature!


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## scomac (Aug 22, 2009)

Beware of directly applying lessons from US centric experiences to the Canadian situation. While the theme may rhyme, it doesn't necessarily mean that it will be replicated.


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## 44545 (Feb 14, 2012)

Benjamin Graham's "The Intelligent Investor" talks about preferred shares. Specifically, in the latest edition of the book, Jason Zweig's comments on Chapter 4 include: 



> *Preferred stock.*
> Preferred shares are a worst-of-both-worlds investment. They are less secure than bonds, since they have only a secondary claim on a company’s assets if it goes bankrupt. And they offer less profit potential than common stocks do, since companies typically “call” (or forcibly buy back) their preferred shares when interest rates drop or their credit rating improves. Unlike the interest payments on most of its bonds, an issuing company cannot deduct preferred dividend payments from its corporate tax bill. Ask yourself: If this company is healthy enough to deserve my investment, why is it paying a fat dividend on its preferred stock instead of issuing bonds and getting a tax break? The likely answer is that the company is not healthy, the market for its bonds is glutted, and you should approach its preferred shares as you would approach an unrefrigerated dead fish.


EDIT - I believe scomac's comment was directed at me as I reposted this and deleted the first instance.

Yes, point taken, there are differences between the US and Canada. I'll stick with broad index funds I understand rather than preferreds which I don't.


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## scomac (Aug 22, 2009)

> *Preferred stock*.
> Preferred shares are a worst-of-both-worlds investment. They are less secure than bonds, since they have only a secondary claim on a company’s assets if it goes bankrupt. And they offer less profit potential than common stocks do, since companies typically “call” (or forcibly buy back) their preferred shares when interest rates drop or their credit rating improves. Unlike the interest payments on most of its bonds, an issuing company cannot deduct preferred dividend payments from its corporate tax bill. Ask yourself: If this company is healthy enough to deserve my investment, why is it paying a fat dividend on its preferred stock instead of issuing bonds and getting a tax break? The likely answer is that the company is not healthy, the market for its bonds is glutted, and you should approach its preferred shares as you would approach an unrefrigerated dead fish.


Just remember the perspective that these comments were made from. Graham wrote the first edition in 1949 with the lesson of the Great Depression fresh in his mind. Those situations were completely different than the preferred share market today where much of the issuance was done to meet regulatory capital requirements.

My own personal experience (and the experiences of many I know) investing in preferred shares has been quite rewarding. I can assure you that in the right situations (which were plentiful in 2008-09) the upside was commensurate with the risk being assumed and quite comparable to common stock investment over that time frame.


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## pwm (Jan 19, 2012)

I have:
CPD, GWO.PR.H, GWO.PR.I, PWF.PR.G, POW.PR.D, and RY.PR.A. I sold some mutual funds and bought income producing securities in their place, when I retired in 2005. Pref shares were a part of that process. 

I just did a Quicken report: Average CAR since 2005: 5.31%. Decent return for fixed income in my opinion, and that's dividends, not interest.


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## 44545 (Feb 14, 2012)

scomac said:


> Just remember the perspective that these comments were made from. Graham wrote the first edition in 1949 with the lesson of the Great Depression fresh in his mind. Those situations were completely different than the preferred share market today where much of the issuance was done to meet regulatory capital requirements.
> 
> My own personal experience (and the experiences of many I know) investing in preferred shares has been quite rewarding. I can assure you that in the right situations (which were plentiful in 2008-09) the upside was commensurate with the risk being assumed and quite comparable to common stock investment over that time frame.


Actually, Graham seemed more positive toward preferred shares.

The comment I quoted was by Jason Zweig, written in 2003 I believe, in the commentary sections of the revised edition of the book.


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## tendim (Nov 18, 2010)

PuckiTwo said:


> My major question to the Forum: are Pref Shares a necessity, a must-have in a balanced retirement portfolio? Do most of you own pref shares?


The answer is: it depends. I wrote a post about preferreds a while back, and there are pros and cons to them.



> They are less secure than bonds, since they have only a secondary claim on a company’s assets if it goes bankrupt. And they offer less profit potential than common stocks do, since companies typically “call” (or forcibly buy back) their preferred shares when interest rates drop or their credit rating improves.


Some of the other negatives about preferreds are definitely true. However, like _any_ investment, they should never be taken at face value ,and due diligence has to be undertaken to ensure the firm is a worthwhile one to invest in. With regards to the first part of the quote above, if you are investing in a firm's preferreds, but the underlying fundamentals of the preferreds are flawed, then you should not be investing in the firm anyways. To do so is pure speculation. With regards to the second part of the quote, this is baked into the prospectus of the preferred, and again, only shows that you _must_ do your research before investing! A person who complains about a firm doing a buyback on their preferreds is taking a very short-sighted view of the firm, since the firm is likely purchasing those preferreds because it is advantageous to do so, which benefits all shareholders.


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## pwm (Jan 19, 2012)

Regarding the fact that Prefs can be redeemed, an example follows:

CIBC redeemed my My Series 32 preferred shares in April. I had bought some at issue for $25.00, then more later. ACB per share was $24.22. They were redeemed at $26.00. $1.00 of my gain was deemed to be a special dividend, the rest will be a cap gain. My total return after holding these for 5 years was 6.05%. 

Not a bad return considering it's a combination of dividends and cap gains. I've had this happen before, and I have no problem with the fact that Pref shares can be redeemed. It's in the prospectus, so you know what to expect. So you get your money back? Why is that a problem? Buy some other income producing security and be happy.


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