Following a strong start to the year in January, the preferred share market gave back much of its gains in February. Preferred shares were affected by the substantial stock market volatility that occurred at the beginning of the month. The S&P500 equity index fell over 10% from January 31st through midday February 9th, while the S&P/TSX dropped more than 7%. In large part, the equity selloff was attributed to concerns about higher bond yields hurting corporate profitability as well as equity valuations. Preferred shares response was more muted but, as can be seen in the following chart, clearly tracked the equity weakness early in the month. Over the balance of the period, equities recovered some of their losses, while preferred shares hovered near their lows. The S&P/TSX Preferred Share index returned -1.05% in the month.
Inflows into preferred share exchange-traded funds (ETFs) during February were less than half of the prior months total. Investors continued to opt for active management, as more than three quarters of the ETF deposits went to actively managed funds rather than passively managed ones.
There were only two new issues in February for a total of $400 million. Institutional participation was relatively low, with only 13 institutional buyers of the Manulife Financial shares and 11 buyers of the Industrial-Alliance deal. Because both issuers were regulated by OSFI, there was not a floor dividend rate in either issue. Details of the new issues were as follows:
Manulife Financial also announced in February that it would be extending its MFC.PR.I preferred shares. Initially issued with a dividend rate of 4.40%, the new fixed rate will be 4.731%, as the yield on 5-year Canada bonds has risen since the shares were first priced. The floating rate alternative would have started at 3.817%, but as this is being written Manulife has announced there was insufficient interest in the floating rate option and all the 10,000,000 shares will remain with the fixed rate dividend.
One redemption was announced in February. Artis Real Estate Investment Trust will be redeeming its 3,000,000 U.S. dollar denominated AX.PR.U preferred units effective March 31st.
Natixis Canadian Preferred Share Fund
Security selection was the cause of the Funds shortfall, with one issuer responsible for almost all the variance. Element Fleet Managements common shares fell over 40% in February, which made preferred shareholders nervous and those shares fell 13% to 16% in the month. The drop in the common share price reflected a number of issues. First, the company had been evaluating strategic alternatives, but was unable to find a buyer for itself. Shareholders who had been hoping for Element to be taken over were disappointed and chose to sell. Second, the company had difficulties with a system changeover in the first half of 2017 that prompted a couple of large customers to leave, which caused the company to revise its earnings and revenue projections slightly lower for the next year, with a subsequent recovery anticipated. Third, the companys chairman held a conference call to reassure shareholders following the CEOs announced retirement, but it did little to calm to calm investors.
We have double-checked our research and analysis on Element and we are confident about the companys creditworthiness. The company remains profitable with significant cashflow generation that more than adequately covers the preferred share dividend requirement and capital expenditures. The two major clients that left Element last year accounted for only 3% of its revenues, reflecting the very diversified nature of its business. As well, we believe that the company will be successful in attracting a CEO that will regain the confidence of shareholders. As disappointing as the drop in the Element preferred shares was, 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 purchases of the new Manulife and Industrial-Alliance issues. They were funded with existing cash as well as some trimming of lower yielding issues.
Market Outlook and Strategy
In the short run, preferred shares appear to be 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.
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. Several 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.