Why The Rally In Preferred Shares May Not Be Over Yet

by: Aubrey Basdeo

Canada's preferred share market has been rallying for almost two years since bottoming in late-2015, but it could remain an attractive option for income-oriented investors looking to diversify their holdings.

In part, that's because many preferred shares provide relatively high yields in relation to other yield-bearing investments such as Government of Canada bonds. In addition to that, however, the market for preferred shares may continue to get a lift from today's interest rate environment and a potentially more favourable supply and demand dynamic.

Interest rates

The S&P/TSX Canadian Preferred Share Index is about two thirds invested in rate reset preferred shares that are adjusted every five years based on a fixed yield spread above the five year Government of Canada bond. As a result, the index has generally moved in tandem with government yields (see chart below), and may benefit from a period of stable, if not rising, interest rates in the months ahead.

Less supply

Investors may recall that preferred share prices were hurt by a supply headwind in late 2015 and early 2016. At the time, the country's big banks were under pressure to shore up their Tier 1 capital requirements under Basel III and NVCC preferred shares were the only Tier 1 compliant instruments available - at least until now. In September, the Bank of Nova Scotia (NYSE:BNS) filed a prospectus with the SEC south of the border to issue USD-denominated notes that will also be Tier 1 compliant. Other banks are expected to follow suit, which should mean less bank issuance of preferred shares moving forward.

This post originally appeared on the BlackRock Blog.