For the second month in a row, equity market volatility caused weakness in preferred share prices. During March, U.S. president Trump threatened to impose tariffs; first on steel and aluminum and then on certain goods imported from China. The U.S. actions, if carried out, risked initiating a trade war that would reduce global growth and corporate profitability. Stocks sold off in reaction, and preferred shares followed suit. The preferred share market also had to deal with difficulties faced by Enbridge Inc., which accounts for about 8% of the preferred shares outstanding in Canada. Enbridge preferred shares already traded at higher yields than some of its competitors shares due to its reorganization in late 2014 and a massive capital funding requirement in the next few years. In March, the U.S. Federal Energy Regulatory Commission (FERC) ruled that master limited partnerships (MLPs), of which Enbridge has two, would no longer be allowed a previous income tax break. Reduced revenue projections for Enbridges MLPs caused its preferred shares to weaken further. The S&P/TSX Preferred Share index returned -0.66% in the month.
Perpetual issues enjoyed the strongest returns during the month, rising 0.6%. Investor demand and lower long-term bond yields were responsible for the good performance of perpetuals. Rate reset issues, in contrast, returned -1.4% in the month. Floating rate issues were the weakest sector, declining 1.5%.
Within preferred share exchange traded funds (ETFs), investors continued to choose actively managed ETFs over passively managed ones. The three largest actively managed had net deposits of $135 million. The total value of the two main passive ETFs shrank as ZPR had $34 million of withdrawals, while CPD attracted only $17 million of deposits.
There was only one new issue in March. TD Bank brought a rate reset preferred share issue that was met with good demand and was upsized from $250 million to $350 million. A total of 19 institutional investors participated in the issue. Details of the new issue were as follows:
Bank of Nova Scotia announced that it would be redeeming its BNS.PR.P fixed rate reset preferred shares and the linked floating rate BNS.PR.A series. The shares did not have Non-Viability Contingent Capital provisions, and therefore would receive zero capital treatment after 2021. As the shares were only redeemable once every five years, it made sense that the bank chose to redeem them now. The announcement sparked small rebounds in other series of non-NVCC bank preferred shares that are redeemable in the next few quarters.
Natixis Canadian Preferred Share Fund
Continued weakness in the Element Fleet Management preferred share holdings was offset by good performance in other holdings, including the overweight allocation to perpetual issues.
Element Fleet Management preferred shares were weak in March, declining between 5.0% and 7.5% from already depressed levels. The company released earnings during the month that were in line with analysts expectations, but there were some concerns about covenants on the firms bank loans that caused the shares to decline. We remain confident about the companys creditworthiness. The company is profitable with significant cashflow generation that more than adequately covers the preferred share dividend requirement and capital expenditures. As disappointing as the drop in the Element preferred shares has been, we believe it is transitory and will be reversed in the coming months. As the Element preferred shares rebound, the performance of the fund should recover.
Noteworthy transactions during the month included the purchase of the new TD.PF.J issue. We decided to realise profits, selling the NA.PR.C holding because its high reset spread made it likely to be redeemed and its yield was uncompetitive. We also realised profits by selling the TD.PR.T holding that is expected to be called in July. The W.PR.J holding was reduced to lower the overall exposure to the Enbridge corporate family even further below market weight. These and other sales resulted in the funds cash level rising to 4.7% at month end. We will maintain the elevated cash level as a defensive strategy until the market finishes consolidating.
Market Outlook and Strategy
In the short run, preferred shares are taking a breather from the rally that began two years ago. New issues are not attracting overwhelming interest from either institutional or retail clients and dividend rates on new issues have edged slightly higher. Similarly, demand for preferred share ETFs has lessened in recent weeks. Given that over a third of existing preferred share issues have current yields or yields-to-call below 4.00%, a level we view as expensive, some consolidation would make sense. As a result, we are maintaining the somewhat elevated cash position as a temporary defensive measure.
From a longer-term perspective, most preferred shares continue to be attractive. Relative to bonds, the yields available on preferred shares are significantly higher, even before the more favourable tax treatment is considered. A number of perpetual issues have yields of 5.50% or better. In addition, if the consensus regarding bond yields trending up is correct, rate reset issues will continue to increase their dividend rates. The higher dividend rates, in turn, should be supportive of prices. Another reason for holding preferred shares is their lack of correlation with bonds at a time when bonds are struggling to hold their values.
For more information about Natixis Canadian Preferred Share Funds, please contact your financial advisor.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual fund securities are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer.
This release may contain forward-looking statements which reflect the current expectations of Natixis Investment Managers Canada LP and/or its sub-advisor, J. Zechner Associates Inc. (J. Zechner). These statements reflect the applicable managements current beliefs with respect to future events and are based on information currently available to such management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements including, without limitation, those listed under the heading Risk Factors in the Natixis Investment Managers Canada LP Funds prospectus, which is available on Natixis Investment Managers Canada LPs website and on SEDAR at www.sedar.com. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this release. Although the forward-looking statements contained in this release are based upon what Natixis Investment Managers Canada LP and/or J. Zechner believes to be reasonable assumptions, Natixis Investment Managers Canada LP and J. Zechner cannot assure investors that actual results, performance or achievements will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this release and Natixis Investment Managers Canada LP and J. Zechner do not assume any obligation to update or revise them to reflect new events or circumstances.
Natixis Investment Managers Canada LP is the manager of the Fund and is an affiliate of Natixis Investment Managers S.A.