Every month the Money Reporter publishes a comprehensive list of the best bonds to invest in including 13 Canadian corporate bonds and 38 Canadian federal and provincial government bonds and 15 of the best Canadian preferred shares─both straight and floating rate─that it recommends for the portfolios of income oriented investors.
What you need to know about bonds
Before you buy a bond, ask these five questions:
■ What’s the bond’s price? Your broker will quote a price per $100 of par value. Most investment dealers sell bonds in quantities as low as $1,000 of par value. Instead of charging you a commission, they build their profit into the price of the bond.
■ What’s the total cost? You pay the seller for interest that has accrued since the last interest payment. (You get this interest back with the next interest payment, along with the interest you’ve earned since you bought.)
■ What’s the yield to maturity? This takes into account the gain or loss at maturity, if you buy at a price other than par value.
■ How much of the gain is tax-free? If you buy a bond below par, any capital gain you make qualifies for favourable tax treatment. Only 50 per cent of the capital gains are taxable.
■ Can I get a better price? If the yield sounds low, ask your broker if he can give you a better price. Or, try another broker. It always pays to comparison shop.
What to do about bonds now
Since late October, Canadian bond prices have fallen. By mid-November, the FTSE TMX Canada Universe Bond Index had declined 0.8 per cent. The Universe Government Bond Index led the way, falling 0.9 per cent, while the All Corporate Index limited its loss to 0.5 per cent.
While the retreat in bond prices may reflect a more “risk-on” attitude by investors — or in other words, more comfort with investing in riskier assets such as equities — it’s probable the decline is a reaction to the greater likelihood the U.S. Federal Reserve will start to raise interest rates in December.
Since our last update on bonds, all our recommended bonds, with the exception of a few strips, are down.
We continue to recommend a 40-per-cent weighting in cash and fixed income if you have an average risk tolerance. In the meantime, the overall yield on bonds remains low, but you can beef up your return by going with more recommended corporate bonds and preferred shares as needed.
What you need to know about preferred shares
■ The dividend tax credit makes $1 of dividends equal to well over $1 of interest income for most taxable Canadian investors. Even U.S.-dollar dividends paid by Canadian firms get this tax credit.
■ You only get preferred dividends when the company’s directors feel the company can afford to pay. But a company has to pay all preferred dividends before common shareholders get anything. Dividends are riskier than interest because companies can stop paying dividends without risking bankruptcy.
■ A company must pay off all cumulative dividends—or ‘dividends in arrears’—before it can resume paying common dividends.
■ Floating-rate preferreds pay a dividend that varies with the banks’ prime lending rate.
■ Redemption is the company’s right to buy your preferreds back at fixed times and prices. Most preferreds are redeemable. If you buy above the redemption price, remember you could lose some of your capital. If preferreds trade below their redemption prices, you could earn capital gains. Keep the yield-to-call in mind.
Preferred securities and preferred split shares
■ Preferred securities are unsecured junior subordinated debentures. They are hybrid investments, meaning they have characteristics of a bond and preferred share.
■ Like bonds, the payments you receive are 100% taxable. Preferred securities also have a maturity date (usually 49 years from the date of issue). They rank ahead of preferred shares in bankruptcy.
■ Like preferred shares, preferred securities have a $25 par value and trade on the stock exchange.
■ The issuing company has the right to defer interest payments at any time for up to 20 consecutive quarters. Interest accrues but will not compound. Preferred securities are redeemable five years following their issue.
■ Split share corporations are created to hold one or more common shares, called portfolio shares. Portfolio shares are artificially split into preferred shares and capital shares.
■ Preferred split shares receive all the dividends from the portfolio shares. Typically, it means the dividend yield will be twice the yield of the portfolio shares.
■ Split shares have an annual retraction date when the company buys back a certain number of shares. There’s also a final redemption date when all the preferred split shares are redeemed.
■ Preferred split shares may be redeemed for less than par value if the portfolio shares drop below the par value of the preferred split shares.
What to do about preferred shares now
Preferred shares, which typically don’t bounce around too much from month to month, have gone on a wild ride this year.
The S&P/TSX Preferred Share Index, for example, has fallen 16.7 per cent since the beginning of the year. The good news is that this loss would have been worse had it not been for a recent rally among preferreds. So far in the fourth quarter, the Preferred Share Index is up 8.6 per cent; and for the month so far, it’s up 3.2 per cent.
Recent market action suggests the worst might be over for preferreds. There have been significant inflows into preferred share exchange-traded funds, perhaps reflecting the attractive values that preferreds now offer. Factors that may constrain the rally include the low Bank of Canada overnight rate, which hit rate-reset preferreds hard earlier this year, and potential new supply of preferreds coming into the market over the next few months.
We favor our straight fixed-rate preferreds over our floaters and fixed-floaters for now.
Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846