What to do about bonds and preferred shares now

Every month the Money Reporter, the newsletter for investors whose interest is more interest, publishes its list of recommended bonds and preferred shares.

What to do about bonds now

The Canadian bond market has moved mostly sideways over the past month as investors try to assess the impact of Donald Trump’s policies on inflation. Consequently, there has been little change in the year-to-date performance of the FTSE TMX Canadian Universe Bond Index. The index is up 0.35 per cent, with corporates continuing to outperform government issues.

We believe bond yields will increase gradually over time. But in the near term, there are still factors that will work to keep yields low. They include the fact that economic growth is still restrained, and may remain so despite President Trump’s pro-growth agenda. Then too, central banks continue to maintain a large amount of monetary stimulus in place.

Balanced investors, therefore, should underweight fixed-income securities, with a portfolio weight of about 40 per cent. You may also want to split that allocation with a 55-per-cent weighting in corporate bonds, and the remainder in governments, as spreads will likely continue to narrow.

What to do about preferred shares now

We include preferred shares along with bonds or GICs in our recommended fixed-income weighting. After all, there are few differences between corporate bonds and preferred shares except for their risk and the different tax treatments of their income. To some extent, then, the split between them will depend on your personal tax situation. But, in general, given the higher risk profile of preferreds, we generally recommend they account for no more than about five per cent of your overall portfolio.

We also recommend that, within your preferred share allocation, you continue to overweight straight preferreds relative to floating-rate preferreds. Despite the rise in bond yields in recent months, we’re still in a very low yield environment, and it still appears it will be some time before the Bank of Canada raises its overnight rate target. We, therefore, consider the risk of being in straights versus floaters well worth it, especially when you consider that many of the former currently yield five per cent or better.

 

This is an edited version of an article that was originally published for subscribers in the March 17, 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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