Preferred shares once again demonstrated their diversification value in June. Global headlines and financial markets were dominated in the month by the British referendum to stay or leave the European Union. In the aftermath of the surprise result to leave the E.U., equity markets such as the S&P/TSX in Canada and the S&P 500 in the United States initially fell over 6% in value and bond yields plunged to record lows. In contrast, preferred shares, as shown in the graph below, seemed to pay scant attention to the Brexit vote.

Preferred Shares and Brexit

For the month as a whole, the S&P/TSX Preferred Share index returned -0.63%. Perpetual preferred shares were the strongest sector, gaining 1.52%. In contrast, the largest preferred share sector, rate resets, declined 1.32%. Floating rate issues were even worse performers, dropping 2.16%. The weakness in the month was partially due to selling that originated from an international preferred share ETF that had held 74% of its investments in Canadian preferred shares. Selling by U.S. based dealers in illiquid conditions caused the preferred share market to drop 2.5% in a matter of hours, although it recovered most of the losses in subsequent trading.

There was only one new issue in June. National Bank brought a 5.40% rate reset issue with a 466 basis point reset spread. The issue was upsized from $250,000,000 to $400,000,000, and institutional buyers accounted for 64% of the purchases. We thought the deal attractive and participated in it.

In contrast with last year, investors recently have been less inclined to take the floating rate option when their issues are resetting the dividend rate. During June, Manulife Financial announced that 21% of holders of MFC.PR.F (+141 bp. spread) chose the floating rate option, Shaw Communication stated that 17% of holders of SJR.PR.A (+200 bp. spread) wanted the floating rate option, Brookfield Asset Management said that 14% of BAM.PR.R (+230 bp. spread) would be converting to floating rate dividends, and Brookfield Office Properties announced that there was insufficient demand from BPO.PR.N (+307 bp. spread) holders to establish the floating rate series.

One redemption was announced in the month: Bank of Nova Scotia called the BNS.PR.M 4.50% perpetual issue. The issue did not have the Non-Viable Contingent Capital feature and was, therefore, subject to declining capital treatment by the banking regulator. The bank waited until the redemption price had declined to par to call the shares.

Record low government bond yields have pushed corporate bond yields lower, making the higher yields of preferred shares even more attractive on a relative basis. We have seen increased interest in preferred shares from traditional institutional bond investors searching for more attractive yields, and we believe that trend is likely to continue.

We continue to prefer the simplicity and higher yields of perpetual issues compared to rate reset issues. The bifurcation of the rate reset sector continues, with older issues struggling to hold their value as reset dates approach and newer issues with floors or dividend rates above 5.00% seeing continued demand and rising prices. In the case of the bank issues that came to market since last fall, many have appreciated beyond fair value in our opinion. They appear likely to be redeemed at the first 5-year reset opportunity and their yields to the potential call are unattractive compared with other issues. As a result, we are taking advantage of market demand to realize gains and reduce our holdings of those issues.