Why 2019 could be the year for preferred shares

The final quarter of 2018 was no picnic for participants in the preferred share market. After several months of relative stability – a respectably performing equity market, rate-creep within expected boundaries – widespread turbulence, which first revealed itself in October, started negatively affecting the credit spread on investment-grade and high-yield products in the space, causing a spike in the number of sellers.

“With the preferred share market, it’s a small market and it’s not really liquid,” says Nicolas Normandeau, Vice-President and Portfolio Manager, Fixed Income, Fiera Capital. “And when the markets started weakening in the last quarter of 2018, volatility increased and there were mainly sellers and not many buyers. The preferred shares market lost close to 9%, all of it in the fourth quarter.”

But despite that contraction, Normandeau and Fiera Capital are still intensely bullish on the potential of preferred shares in 2019. Investment-grade yields are recovering most of the weakness they experienced last year, and the U.S. high-yield equity market is undoubtedly on fire, but the preferred space is still shaking off the cobwebs, making for an intriguing amount of potential upside.

“What have preferreds been doing since the beginning of the year? Nothing. They’re flat to -0.5% on the year, so I would say they’re attractive compared to everything else that has already been re-priced,” Normandeau says, adding that a slew of potential new offerings from banks and life insurance companies could bring some much-needed volatility to the market in 2019. “Generally speaking, we expect to see buyers coming back.”

Normandeau says the relative limited size of the preferred space means major share purchases aren’t required to put upward pressure on the overall market and increase liquidity, adding another dimension to its potential. “Our expected return for the asset class is around 5%. It’s at zero right now, so that’s why we think the asset class is attractive,” he says.

It’s no surprise then that Normandeau believes now is an opportune time for investors to consider the Horizons Active Preferred Share ETF (HPR), an ETF which Fiera Capital sub-advises.

“The ETF is actively managed, and for investors looking at different options, I think it’s great to buy a fund that is actively managed,” Normandeau says. “With HPR, we’re not just tracking a benchmark like other funds. Our goal is to add value, so we do the credit work for every issuer, we do our analysis on interest rates and after that, we do the securities selection.”

Normandeau says HPR’s typical bid-ask spread is only one cent, while the bid-ask on single issues of other preferreds can be as high as 50.

The complexity of the preferred market means a fund like HPR can alleviate much of the confusion – and the cost – associated with acquiring individual preferred shares. “You get access to the market more quickly with fewer trading costs,” Normandeau says. “We’re always trying to take the cheapest issue for every issuer.”

Advisors still questioning the potential of the preferred shares market after several months of quiet are encouraged to keep the bigger picture in mind.

“It’s an attractive asset class,” Normandeau says. “You’re getting lots of diversification versus bonds. There’s more volatility than the corporate bond market, but the upside is still attractive. The tax treatment, because it’s dividend over interest, can add a little more attractiveness as well. And as we’re not expecting a recession, I think it’s still a good place to be.”

This is a special promotional feature produced in partnership with Horizons ETFs.