I find Larry MacDonald’s Me and My Money columns interesting because they give insight into the reasoning people use for making investments. Two recent columns are about an investor who likes preferred shares and another investor who likes professional money management. In the first case I had a misconception about floating-rate preferred shares and in the second case the investor has mistaken ideas at the core of her reasoning. Preferred Shares Matt Byers likes preferred shares and says “Floating preferred shares are also a perfect hedge against inflation.” Typically, preferred shares pay a fixed dividend, such as $1.25 per year, and the issuer can redeem them for $25 any time after a particular date. For this example the nominal dividend rate is 5%. The issuer will redeem the shares if it can get a better deal.  However, with floating-rate preferred shares, the rate changes with prevailing interest rates. When you buy non-floating rate preferred shares, you are owed a...

Preferred shares are tempting for fixed income investors mainly because they pay higher returns than many other fixed-income investments. These higher returns come with the inevitable higher risks. BlackRock has helped to spread the risk by coming out with a new exchange-traded fund called XPF that tracks the S&P/TSX North American Preferred Stock Index. The downside is the cost. The management fee is 0.45%, which is fairly high for an index ETF. The HST adds a little more: 0.03%. Then there is the currency hedging. Half the fund is invested in U.S. preferred shares and the currency exposure is hedged back to Canadian dollars. Such hedging usually seems to cause tracking errors in fund returns. Another thing to consider is that while XPF has 120 underlying holdings, they are from a relatively small number of companies. For example, I counted 18 holdings of various Royal Bank preferred shares. Presumably, if there is risk of default on one Royal Bank preferred share, th...

In these days of low fixed-income returns, preferred shares of Canadian banks are offering impressively high rates. In some case the dividend yield is above 6% per year. What gives? Let’s take Bank of Nova Scotia series 12 preferred shares (ticker: BNS.PR.J) as an example. As I write, these preferred shares are trading for $21.65 and pay a dividend of $1.52 per year (actually a half-cent more than this). This is a dividend yield of 6.08%. According to the prospectus , Bank of Nova Scotia can redeem these shares any time after 2013 October 29 for $25 each. So, you either get to keep collecting your 6.08% each year or they take the shares off your hands for a capital gain of $3.35 per share. This sounds like heads I win and tails I win. Lenders are still offering rates on 3-year closed mortgages below 4%. So, there is a spread of over 2% between what you could pay for a mortgage and what you could collect on these preferred shares. There is always the possibility that Ban...

The dividend yield reported on preferred shares is often misleading. These reported figures don’t take into account potential gains or losses when these shares are redeemed. Unwary investors can get surprised if they chase high yield without reading the fine print. Preferred shares are issued by companies to raise capital. Typically, they are sold for $25 each and promise fixed quarterly dividends until they are redeemed for $25 each. With common stock, shareholders own a slice of the company, but investors in preferred shares just get dividends. The name “preferred” comes from the fact that if the company has financial trouble, owners of preferred shares get paid before owners of common stock. Just because a preferred share starts and ends its life at $25 doesn’t mean that it holds steady at $25. If market conditions make the fixed dividend payment more or less attractive, the share’s price will fluctuate up and down. Usually preferred shares get a higher dividend (in perc...