Christian Farstad - Vancouver ScotiaMcleod

Often people believe that preferred shares are relatively easy to understand and pretty straight forward. However, they are much more complicated than you may think.

Many investors are looking for a better yield that they can get right now with a GIC, and are considering purchasing preferred shares for the first time. If this is you, please read this article before you buy preferred shares!

Individual Canadian companies issue preferred shares to investors.  They are similar to bonds in that they are issued with a par price (usually $25) and pay an agreed upon dividend for each share. However, unlike bonds, the shares trade on the TSX like regular common shares and the payments are treated as dividends instead of interest income.

Here are some basic types of preferred shares:

Retractable – these preferred shares have a term to them with a fixed maturity date that allows the holder to force the issuer to redeem the shares at par value on a specific date.

Perpetual Preferred Shares – these preferred shares have no maturity date. They pay a fixed dividend indefinitely or until the company calls them.

Rate Reset Preferred Shares – these shares pay a fixed dividend until a reset date, which is usually also the call date. On that date and every reset after, if the issuer does not call the shares, the holder has two options:

1. Lock in a fixed dividend until the next reset date. This is already set as a spread over an equivalent term Government of Canada bond
2. Exchange for a floating rate preferred share. This rate is based on a 3 month Government of Canada Treasury Bills plus the same spread as in option 1.

Fixed Floating Rate Preferred Shares – these shares pay a fixed dividend rate until the reset date, which is typically also the call date. On that date and all reset dates after the investor has 2 options.

1. Lock in a fixed dividend rate until the next reset date
2. Exchange for a floating rate

Floating Rate Preferred Shares – these pay a floating dividend rate based on a reference rate such a prime, although some have a ‘floor’ or minimum dividend.  Some floaters have a ratcheting system that adjusts the dividend whether or not the share trades within a specific price band.

Split and Structured Preferred Shares – these are synthetic preferred shares based on an underlying portfolio of common shares or a portfolio created from more diverse or complex financial instruments, including derivatives.

There are many types of preferred shares as I have outlined above. It is important to know what you are buying and understand why you are buying it. Look at the type of preferred share you are purchasing as well as the rating it has. More on the rating system of preferred shares here:

If you are a conservative investor stick to rate reset or retractable preferred shares. If you believe interest rates will raise you may want to look at floating rate preferred shares.

Understand before you invest! For more comprehensive information on preferred shares download our FREE PREFERRED SHARE GUIDE or to sign up for my free weekly newsletter click here