Floating rate preferreds offer some protection

Every month the Money Reporter, the newsletter for investors whose interest is more interest,   publishes its list of recommended bonds and preferred shares. The longer-term outlook is for yields to move gradually higher. Floating rate preferreds will offer you some protection against rising rates.

What to do about bonds now

Bond_InvestingCanadian bond prices have weakened in the wake of speculation that the Bank of Canada may raise its overnight rate sometime this year, as opposed to previous expectations of a rate hike next year. The FTSE TMX Universe Bond Index has declined about 0.3 per cent since the beginning of June.

Still, the year-to-date trend has been toward lower yields, as reflected in the 3.2-per-cent return of the universe bond index. This has increased valuation risk among bonds, making them less attractive.

We, therefore, continue to recommend you underweight bonds in your portfolio. In a balanced portfolio that means 40 per cent in fixed income and cash, less than a normal weighting of 45 per cent. Within this allocation, we recommend an equal split between governments and corporates as the risk premium between the two has narrowed this year. Keep terms to maturity on the shorter side.

What to do about preferred shares now

Right now, we advise income investors to underweight fixed-income securities generally. As preferred shares are frequently regarded as one type of fixed-income security, how much of the underweight you make up of preferreds in your own portfolio will in part depend on your personal tax situation.

But not withstanding your tax situation, and within that preferreds-versus-overall-fixed-income allocation, we recommend you equally weight straight perpetual preferreds relative to floating-rate preferreds now. Though Canadian interest rates continue to hover near all-time lows, we no longer expect them to be stable for several more quarters. The Bank of Canada could raise its overnight rate as early as July, though a fall increase looks more likely.

And the longer-term outlook is for yields to move gradually higher. Floaters will offer you some protection against rising rates, as their dividends will reset at higher levels. The cost for this is a lower current yield than is typically offered by a perpetual, but the protection you receive may be worth it.

This is an edited version of an article that was originally published for subscribers in the July 7, 2017, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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