The preferred share market dropped sharply during April in illiquid trading conditions. Investment dealers reported the selling pressure appeared to be coming from retail investors, as there was relatively little block trading involved in the selloff. Institutional investors appeared to step back from buying until prices stabilized. The selling occurred directly through sales of individual issues and indirectly as preferred share ETFs and mutual funds experienced consistent redemptions. The selling may have been triggered by volatility in equity markets caused by the Russian/Ukrainian war, ongoing supply chain disruptions, and more aggressive monetary policy from both the Bank of Canada and the U.S. Federal Reserve. Sharply higher bond yields may also have prompted some selling by investors demanding higher yields on preferred shares. However, investors seemed to ignore the very positive implications of the 36 basis point jump in 5-year Canada bond yields for the future dividend rates of rate reset preferred shares. The 5-year Canada bond ended the month at a yield of 2.75%, a level not seen since 2011, and will result in significantly higher dividends going forward. The S&P/TSX Preferred Share index returned -7.04% in April.

Canadian economic activity was strong in April. Economic growth was robust, as GDP grew by 4.5%, up from 3.5% the previous month. Employment increased by 72,500 jobs, which pushed the unemployment rate down to 5.3%, an all-time low. The tightness of the labour market was also reflected by the increase in average hourly wages of 3.7% versus year ago levels. Consumers remained optimistic as retail sales continued to grow. Worryingly, Canadian inflation surged to 6.7%, which was the highest level since 1991, and that led investors to anticipate further rate increases from the Bank of Canada.

The only new issue in April was from Brookfield Renewable Partners, which issued $150 million perpetual preferred units. The BEP.PR.R units had a distribution rate of 5.50% that will include dividends, interest and return of capital. Curiously, the use of the issue proceeds was to redeem the BEP.PR.K rate reset units at the end of the month, although the new issue was not large enough to pay for the entire $250 million redemption. The issuer was able to reduce its financing cost, however, as the BEP.PR.K units would have reset to over 6.30% if they had not been called. The institutional/retail split for the BEP.PR.R new issue was 27%/73%.

The BEP.PR.K redemption was the only one in April, marking it as the lowest redemption month in over a year. However, the ongoing trend of redemptions of high reset spread issues will continue, as two more series of preferred shares totaling $1.5 billion or 2.60% of the market have been called by their respective issuers. Details of the issues to be redeemed are as follows:

No preferred shares reset their dividend rates in the month.

The seven largest preferred share ETFs experienced total net withdrawals of $154 million in April. This was the third consecutive month that aggregate flows were negative. Only TPRF, which holds common shares in addition to preferred shares, saw any significant net deposits.

No preferred shares reset their dividend rates in the month.

The seven largest preferred share ETFs experienced total net withdrawals of $154 million in April. This was the third consecutive month that aggregate flows were negative. Only TPRF, which holds common shares in addition to preferred shares, saw any significant net deposits.

Zechner Associates Preferred Share Pooled Fund

The fund returned -7.42% in April, which was slightly worse than the benchmark result. The selloff occurred in illiquid conditions, which meant price changes in the period were indiscriminate. We remain confident in the fund’s holdings and anticipate that performance will recover relatively quickly. We also note that the recently added TD 5.75% institutional preferred shares declined only -1.15% in April, reinforcing our view that the selloff was driven by retail selling.

Given the illiquid trading conditions in the month, activity in the fund was kept low to minimize transaction costs.

Outlook and Strategy

We believe the selloff in April presents a buying opportunity for preferred share investors. We think the market has not yet appreciated the magnitude of dividend increases that may result from the recent rise in 5-year bond yields. And with the Bank of Canada likely to continue raising rates at its next few meetings, the bond yield (and dividends) may rise further. Another reason for optimism is that the recent market decline has raised preferred share yields, making them even more attractive versus alternatives. (For reference, the average yield of the fund’s preferred shares was over 5.40% at the end of April.) We also note that, while preferred share and bond returns can be highly correlated over brief periods, in the long term they have virtually zero correlation. That should be beneficial for preferred share investors as bonds remain at risk from further rate increases by the Bank of Canada.

As well, the ongoing redemptions of rate reset series with high reset spreads should continue to provide support for the market. We also note the relatively low volume of trades that resulted in the decline during April. A recovery could be relatively quick once the institutional buyers’ strike ends.