I have noticed that a lot of the stocks making new lows on the TSX have been preferred shares. Why are preferreds getting hit so hard?
First, let’s put the decline into perspective.
Since Oct. 1, the S&P/TSX Preferred Share Index has skidded by about 9 per cent (excluding dividends). That’s a hefty drop for sure, but for the three years ended Sept. 30, the index posted a cumulative total return (including dividends) of 32.8 per cent. So preferred shares have only given up a portion of the gains they recorded over the past few years.
Why the recent weakness? Well, the preferred share market nowadays is dominated by rate-reset preferreds, whose dividends are adjusted every five years at a spread over the five-year Government of Canada bond yield. Rate-reset preferreds tend to do well when interest rates are rising (in anticipation that dividends will reset at higher levels) and do poorly when rates are falling (in anticipation of dividend cuts).
Back in 2015, for instance, when the five-year Canada yield languished below 1 per cent for most of the year, many rate-reset preferred shares cut their dividends and the index posted a total return of negative 15 per cent. But as the five-year yield moved higher over the next few years, the index rebounded, producing solid gains for preferred share investors.
Now, with the global economy showing signs of slowing, what’s happened is that interest rate expectations have moderated. The five-year Canada yield has slipped to about 2.29 per cent, down from about 2.47 per cent two weeks ago. That’s a significant drop in a short period of time, and it was enough to rattle the preferred share market, which is thinly traded and dominated by retail investors.
James Hymas, who manages a preferred share fund and writes the PrefLetter, said the recent drop may have been exacerbated by tax-loss selling, in which investors dump losing stocks in order to offset capital gains on their winners.
“There’s also a certain amount of ‘fighting the last war’ syndrome,” Mr. Hymas said in an e-mail. “People remember what happened the last couple of times the Bank of Canada cut its [benchmark] rate (January 2015, especially) and are terrified it will happen again.”
Despite those fears, after the recent drop many preferred shares now offer even more attractive yields. That’s especially true considering that preferred shares, unlike corporate bonds, qualify for the dividend tax credit. What’s more, assuming the five-year Canada yield stays roughly where it is, most preferreds will actually raise their dividends – not lower them – on the next reset date, Mr. Hymas said.
“My advice to current holders of preferreds remains the same as it was during the credit crunch: Shut up and clip your coupons,” he said.
What are the tax implications of Loblaw Cos. Ltd.’s spin-out of Choice Properties Real Estate Investment Trust?
As I discussed in a recent column, Loblaw minority shareholders received 0.135 of a George Weston Ltd. share in exchange for giving up their interest in Choice Properties REIT.
From a tax perspective, there are a couple of things you need to know.
First, the George Weston shares were received on a tax-free basis.
Second, Loblaw shareholders will need to calculate a new adjusted cost base (ACB) for their Loblaw shares. They will also need to determine an ACB for their new George Weston shares.
The math is fairly straightforward. In a press release, the company said the new ACB for Loblaw shares should be equivalent to 80.1 per cent of the investor’s old Loblaw ACB, with the remaining 19.9 per cent allocated to the new George Weston shares.
For example, say an investor bought 200 Loblaw shares at $50 each several years ago, for a total ACB of $10,000. Following the Choice spin-out, the 200 Loblaw shares would have a new ACB of $8,010 (80.1 per cent of $10,000) or $40.05 a Loblaw share.
The remaining $1,990 (19.9 per cent of $10,000) of the original ACB would be allocated to the 27 George Weston shares (0.135 times 200) received in the transaction. That works out to an ACB of $73.70 for each George Weston share.
Note that the investor’s total cost base of $10,000 hasn’t changed – it’s just been divided between the existing Loblaw shares and the new George Weston shares. When an investor ultimately sells all or part of her Loblaw or George Weston shares, she would use the new ACBs per share to determine her capital gain or loss.
Just to be clear: The ACBs per share calculated here apply only to this example. Investors must use the above formula to calculate the ACBs for their own situation.
It’s possible that your broker may have already done the calculations for you. If you’ve noticed that the “book value” or “cost basis” of your Loblaw shares has changed on your brokerage statement, that’s likely the reason. Still, it doesn’t hurt to check if your broker’s ACB is correct.
E-mail your questions to jheinzl@globeandmail.com.
John Heinzl