With interest rates looking set to continue rising, investors are seeking opportunities that benefit from the evolving investment environment
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With interest rates looking set to continue rising, investors are seeking opportunities that benefit from this evolving investment environment. One option increasingly well suited to the current landscape in Canada is the preferred share market, and specifically the rate reset.
As one of the few asset classes that tend to perform well when interest rates increase, rate reset preferred shares are key for investors in the current environment. With a rate reset preferred share, the coupon is reset in relation to the five-year Government of Canada bond rate every five years (after issuance), making it an effective portfolio construction tool, providing balance to a portfolio as bonds and even some equities can be adversely impacted by rising rates.
Mitigating the threats of rising rates has been one of the primary reasons institutions have been adding rate reset exposures to their portfolios through ETFs.
“As a portfolio construction vehicle, a rate reset preferred share has the distinct advantage of providing balance to an overall portfolio strategy,” explains Rob Butler, Director of Regional Sales at BMO Global Asset Management. “Investing in a one to five year laddering approach to rate rest preferred shares means investors can participate in the rising rate environment while equalizing the amount of a portfolio that potentially adjusts to higher rates each year.
Butler believes their inherent structure makes preferred share investments an effective complement to almost any regular Canadian portfolio. “The preferred share space tends to have a low correlation to a core equity holding, such as the TSX, as well as a low correlation to the core Canadian fixed income market,” he says.
The introduction of preferred share ETFs has been a real game changer for Canadian investors. Traditionally, the challenge has been managing and accessing rate reset preferred shares to run a laddered investment strategy, but ETFs now allow investors to get all of the benefits in one investment solution.
Rate resets are similar to bonds in that the rate is set for a specific period. In a laddered rate reset preferred share strategy, a portfolio is constructed with securities of staggered reset dates, so that a fixed portion of the portfolio resets each year. On the reset date either the dividend is adjusted based on the spread above the current five-year government bond yield or the preferred share is redeemed.
The BMO Laddered Preferred Share ETF (ZPR) provides easy access to the asset class and strategy and has become a popular solution among Canadian investors and advisors. Implementing the laddering strategy in an ETF means investors can avoid becoming overly concentrated in any one security. Another, often overlooked, benefit of the BMO Laddered Preferred Share ETF is the enhanced liquidity it provides.
“BMO Laddered Preferred Share Index ETF (ZPR), the largest preferred share ETF in Canada, it is a materially less expensive way to buy and sell preferred share exposure (compared to buying preferred shares directly) and provides an added level of diversification given the 192 rate reset securities currently within the basket*”. Butler says.
*Source: BMO Asset Management, as of April 30th 2018
BMO Global Asset Management is a brand name that comprises BMO Asset Management Inc., BMO Investments Inc., BMO Asset Management Corp. and BMO’s specialized investment management firms.
BMO ETFs are managed and administered by BMO Asset Management Inc., an investment fund manager and portfolio manager and separate legal entity from Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the ETF Facts or prospectus before investing. Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated.
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