Following three consecutive down months, preferred share prices rebounded nicely in May. Share prices rose almost 2.0% in the first two weeks of the month, due to a lack of new issues combined with good investor demand. The pick-up in demand was explained, at least partially, by rising 5-year bond yields in early May, which implied higher preferred dividend rates when issues reset. In the second half of the month, preferred shares gave up some of their gains as bond yields started falling and new preferred share issues weighed on the market. For the month, the S&P/TSX Preferred Share Index returned 0.97%.
In May, preferred share issuers in the news included Kinder Morgan Canada. The company owns the Trans Mountain Pipeline and has been trying to expand its capacity to carry oil from Alberta to British Columbia. The federal government has given its approval for the expansion but the newly elected NDP government in B.C. has been trying to block the project. Several weeks ago, Kinder Morgan announced that it would abandon the expansion if it could not gain certainty regarding approvals by May 31st. In the end, the federal government agreed to buy the existing pipeline and the expansion to ensure it is completed. The fund held Kinder Morgan preferred shares, but as this commentary is being written, has sold them because of the uncertainty regarding how Kinder Morgan would invest the proceeds of the pipeline sale. If the company decides to distribute some of the proceeds to common shareholders or enter riskier businesses, the preferred shares’ credit quality could be adversely impacted.
After more than two months of inactivity, there were three new issues in May. Interestingly, the Intact and Emera deals came to market on the same day (May 17th), while the National Bank issue came on the final day of the month. Only the Emera shares had a dividend floor, because OSFI prohibits financial institutions from issuing shares with that feature. Details of the new issues were as follows:
As can be seen in the table, institutional participation in the new issues was subdued. According to some investment dealers, some investors were avoiding new issues because they felt reset spreads of less than 300 basis points made it less likely that the issues would be redeemed in five years.
Continuing a trend that is over a year long, few investors are choosing the floating rate option when rate reset issues come due. In May, Enbridge announced that there was insufficient demand for the floating rate alternative and all holders of ENB.PR.F would continue to receive fixed rate dividends. Originally issued with a 4.00% dividend rate, the new fixed rate will be 4.689%. Next up for resetting its dividend rate will be CPX.PR.E, as Capital Power announced that it would not be redeeming the issue. The new fixed rate will be 5.238%, up from the original 4.50%, and holders will have until June 15th to choose between the fixed and floating rate alternatives.
Preferred share Exchange Traded Funds (ETF’s) continued to attract new deposits, with actively managed ETF’s garnering the bulk of the new money. The five largest funds gained a total of $114 million in May, with only one, CPD, suffering net withdrawals.
Natixis Canadian Preferred Share Fund
Contributing to the good result was the continued recovery in the value of the Element Fleet Management preferred shares. During May, Element announced a new, credible CEO, changes to its board of directors, and good quarterly results. As well, contrary to some investors’ concerns, Element again demonstrated that it had ready access to capital as one of its subsidiaries raised approximately AUD $1 billion through a securitization. The Element preferred shares gained roughly 9% in May.
Noteworthy transactions, in addition to the sale of the Kinder Morgan Canada preferred shares mentioned above, included participation in the IFC.PR.G new issue. At the same time, we sold the IFC.PR.E perpetual holding because its yield was too low relative to the new issue. We also added to a number of existing rate reset holdings, thereby reducing the cash position to 3% and increasing the rate reset allocation to over 68%.
Market Outlook and Strategy
We anticipate that bond yields will move higher in the coming months. As a result of their respective economies continuing to perform well, both the Bank of Canada and the Fed are expected to reduce the current monetary stimulus by increasing their respective interest rates at their next scheduled meetings. Bond yields should follow the lead of the central banks’ rate moves and move upward. Implicit in our forecast is an expectation that the recent flight-to-quality bid for bonds will dissipate. In addition, we are cautiously optimistic that a full-blown trade war will not develop and cause an economic slowdown. Higher bond yields should bode well for rate reset issue trading at discounts to par. Floating rate preferred issues should also benefit from the anticipated rate increases. Another reason for holding preferred shares is their lack of correlation with bonds at a time when bonds may be struggling to hold their values.
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.
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 management?s 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 LP?s 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.