Bond investing and preferred shares: What to do?

Assuming the global economy gradually improves, we expect corporate bonds to outperform government bonds. Straight preferreds have performed well relative to rate-reset issues and fixed-floaters, both of which have been lowering their dividends.

What to do about bonds

Government bonds have outperformed corporate bonds and debentures this year, but they’ve underperformed corporate issues so far in September.

The FTSE Universe All Government Bond Index is up 3.02 per cent so far in 2015, while the All Corporate Bond Index has returned 2.14 per cent.

So far in September, however, bond returns have slipped, with the All-Government Index down 0.03 per cent, though the Corporate Index has remained flat. Bonds began to climb in late July and continued to make gains in August amidst stock-market turmoil. But now bonds are down about one per cent from the highs reached in August, probably reflecting investors’ greater comfort with risk in equities.

Assuming the global economy gradually improves, we expect corporate bonds to outperform government bonds. That’s because as the economy grows, the credit spreads, or differences in yield between corporate and governments bonds, should narrow, translating into higher prices for corporate bonds relative to government bonds.

Here’s a new convertible bond

This issue, we’ve added the convertible debentures of Chemtrade Logistics Income Fund 5.75% (TSX─CHE.DB.A) to our Money Reporter Fact and Advice Sheet. It replaces Innergex Renewable Energy Inc. 5.75% (TSX─INE.DB) which was recently redeemed.

Convertible debentures are hybrid securities that give you some of the advantages of owning a bond along with the option to exchange it for the common shares of the issuing company. You might say that buying convertible bonds is like buying call options, as they give you the right to buy the common shares at a specified price.

In the case of Chemtrade Logistics, which provides industrial chemicals and services to customers in North America and around the world, the specified price, or its conversion price, is $20.00. Right now, Chemtrade’s common shares trade around $18.24. Assuming the common shares rise above the conversion price, the price of the debentures would also rise and begin “selling off the stock”. That means the debentures would cease to trade like a straight debenture and start to perform in line with the underlying common stock, presenting you with a capital gain opportunity. Chemtrade’s debentures are a higher-risk buy.

What to do about preferred shares

The S&P/TSX Preferred Share Index is down nearly 18 per cent so far this year, as many rate-reset preferred shares have lowered their dividends in response to low interest rates.

In this environment, three out of five of our straight preferreds have performed relatively well, losing an average 7.8 per cent. They are Canadian Utilities, Power Financial and Fortis. They’re perpetual preferreds that pay a fixed dividend, and that has helped them hold up well as many rate-reset issues have lowered their dividend.

Our other two straight preferreds — Brookfield Asset Management and BCE — have performed poorly, losing an average 29.1 per cent. They’re perpetual preferreds as well. But they do not pay a fixed dividend. They’re known as fixed-floaters. That means that every five years, the issuer will reset the dividend at prevailing market rates. In this way they are similar to rate-reset preferreds, thus explaining why these issues have done poorly. We think the selling has been overdone.


Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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