The Money Reporter currently recommends a 40-per-cent portfolio allocation to fixed income securities, and 55 per cent of that in corporates. It is worth considering using some preferred shares to boost the yield on the corporate portion of this allocation. From our monthly review of 15 recommended preferred shares, we name three perpetual, or straight, preferreds we recommend as attractive buys.
What to do with bonds now
Though bond returns lost ground in early April, they’re still up on a year-to-date basis. The FTSE TMX Canada Universe Bond Index is up 1.34 per cent. Corporate bonds have outperformed government bonds over this period, as earlier fears about the global economy have eased in recent months. The Universe All Government Bond Index is up 1.26 per cent since the beginning of the year, while the Corporate Bond Index is up 1.56 per cent.
But not all government bonds have underperformed. In fact, provincial bonds have outperformed corporates, gaining 1.63 per cent so far this year. Federal bonds, meanwhile, are up just 0.89 per cent.
Continuing gains in the bond market means yields remain very low. Yet we continue to recommend a 40-per-cent weighting in fixed income if you have an average risk tolerance. Within bond portfolios, we also continue to recommend a 55/45 split in favour of corporate bonds. These securities not only offer generally higher yields, but they should hold up better than government bonds if the economy picks up.
What to do with preferred stocks now
Preferred shares have continued to recover ground lost in the first few weeks of January. At that time, the S&P/TSX Preferred Share Index declined nearly 16 per cent. Since then, however, the index has rebounded by just over 14 per cent. Still, it remains underwater for the year, having declined 3.6 per cent. Nonetheless, the gains of the past few months may indicate the preferred share market is recovering from its miserable showing last year.
Despite the volatility in the preferred market, our strategy with respect to these securities remains unchanged. We still advise holding more straight perpetual preferreds than floating-rate preferreds.
With our current recommendation of a 40-per-cent portfolio allocation to fixed income, and 55 per cent of that in corporates, it is worth considering using some preferred shares to boost the yield on the latter portion of this allocation. But limit your preferred shares weighting to no more than five per cent of your total investment portfolio.
We prefer our perpetual preferred shares
With Canadian inflation increasing at an annual rate of less than two per cent, it’s unlikely the Bank of Canada will raise its overnight target rate until next year, or even the year after that. That’s why we’ve continued to recommend you emphasize perpetual straight preferred shares over floating rate preferred shares. In our list of recommended preferred shares, we recommend three perpetual preferred shares. They are: Canadian Utilities (TSX─CU.PR.G), Power Financial (TSX─PWF.PR.F) and Fortis Inc. (TSX─FTS.PR.J).
Perpetuals are the traditional type of preferred shares. They pay a fixed dividend for the life of the preferred. Fortis’ perpetuals, for example, pay a fixed dividend of $1.1875 a share. The company will continue to pay this dividend either in perpetuity or until it chooses to redeem the shares according to the redemption schedule provided in the shares’ prospectus.
Because their dividends are fixed, perpetual preferreds are considered to be the most sensitive to changes in interest rates. As prevailing rates rise, for example, you would expect a perpetual’s price to decline to a level that reflects the new rates. The opposite should occur when rates fall. With rates likely to remain stable for some time, we think our perpetuals are attractive buys.
Money Reporter, MPL Communications Inc.
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