If you look at our dividend portfolio, you’ll notice that we only hold common shares that pay dividends. A few readers have emailed me and asked why we don’t hold any preferred shares to take advantage of the higher dividend yields? Why not get higher dividend yields by holding one of the best preferred share ETFs in Canada?
Those are excellent questions. For us, since we are still in the accumulation phase, we are investing in common shares rather than preferred shares with the focus on the overall long term growth rather than the immediate dividend income.
Do preferred shares have a place in an investor’s portfolio? Sure, if you are OK with preferred shares and some of their limitations. However, while individual preferred shares can be attractive because of the higher yields, they can be difficult to understand and manage.
Therefore, for some investors, it may make sense to invest in preferred share ETFs, pay a small amount of management fees, and collect the juicy dividends.
Preferred shares, or preferred stocks, are a special share structure set up by a company. The main difference between preferred shares and common shares is that investors do not have voting rights when holding preferred shares.
If you hold preferred shares, you do not have any say at the annual general meetings. You cannot elect the board of directors or vote on any form of corporate policy.
Preferred shares typically have a higher dividend yield than common shares. For example, TD common shares (TD.TO) currently pay a quarterly dividend of around 3.8%. One of TD preferred shares, TD.PF.A, pays 4.04%. So preferred shares can be beneficial for investors looking for higher yields to produce more dividend income.
One thing to note is that preferred shares are very similar to bonds. Preferred shares are usually set up with a guaranteed fixed dividend in perpetuity. Unlike common shares, where the dividends are declared by the board of directors and never guaranteed, dividends for preferred shares are a fixed amount and are guaranteed.
Therefore, just like bonds, the price of preferred shares is highly dependent on interest rates. When interest rates rise, the value of the preferred stock declines; when interest rates decrease, the value of the preferred stock increases.
If a company goes bankrupt, preferred shares have a greater claim to a company’s assets compared to common shares. Preferred shares also get paid dividends first before common shares. A company can decide to suspend dividends for common shares but has obligations to continue paying dividends for preferred shares.
Essentially, preferred shares are good for investors who are looking for more stable and secure dividends, are ok with no voting rights, and are ok with limited potential of share price appreciation.
Although preferred shares are usually set up with a guaranteed fixed dividend in perpetuity, companies can set a redemption price and date and can eventually pay to redeem these shares.
To make things more confusing, companies can also issue convertible preferred shares. With convertible preferred shares, they can be converted to common shares under specific circumstances.
Just to make preferred shares even more confusing, there are more types of preferred shares. There are rate-reset preferred shares, callable preferred shares, cumulative preferred shares, and other types of preferred shares that companies can create and issue to investors. Each different type has different rules and regulations.
So when you start going down the preferred shares rabbit hole, it can get extremely complicated and time consuming. Hence, it makes a lot of sense to hold a preferred share ETF and let the professional handle the nitty gritty details.
As you can see, preferred shares can get pretty complicated. For example, TD currently has 12 different series of preferred shares with different yields and terms. As an individual investor, it can get very time consuming and confusing to go through the different preferred shares and deciding which one to hold. This is another reason we currently only hold common shares that pay out regular dividends.
For investors looking for a higher dividend yield, holding one of the preferred share ETFs in Canada might be a better approach. This is one of the few scenarios in which I’d be willing to pay some fees to reduce the level of complexity involved, have peace of mind, and simplify my investing life.
Although preferred shares are very similar to bonds, they are much more tax efficient compared to bonds. The Canadian government taxes interest payments from bonds and bond ETFs as ordinary income.
On the other hand, dividends from preferred shares are taxed as eligible dividends and get favourable tax treatment.
One can be even more tax efficient by holding the preferred shares ETFs inside a TFSA or RRSP.
As mentioned, since we are still in the accumulation phase, the overall investment return (i.e. stock price appreciation plus dividends) is more important to us rather than a high initial dividend yield. Although the preferred share ETFs aren’t for us, they may be suitable for other Canadian investors.
Unlike other popular asset classes like the Canadian Bank ETFs, there are only a handful of preferred share ETFs available in Canada with significant net assets. Here are some best preferred share ETFs in Canada to consider.
The BMO Laddered Preferred Share Index ETF, ZPR, has been designed to replicate to the extent possible, the performance of the Solactive Laddered Canadian Preferred Share Index, net of expenses. The fund invests in the holds of the Constituent Securities of the index in the same proportion as they are reflected in the index.
The fund is designed for investors looking for higher income from their portfolios. It invests in a diversified portfolio of rate reset preferred shares. According to BMO, ZPR holdings are lower interest rate sensitive than the full preferred share market.
- Ticker: ZPR
- Inception Date: Nov 14, 2012
- MER: 0.50%
- Dividend Yield: 4.73%
- Distribution Frequency: Monthly
- Net Asset: $2,164.35M
- Number of holdings: 189
At 0.50% MER, this is a very low cost for holding a preferred share index ETF. ZPR holds 194 different preferred shares which provides quite a bit of diversification across the different asset sectors. A quick look at its top 10 holdings showed that ZPR is concentrated on Canadian banks and oil & gas companies.
ZPR can achieve a high yield by investing primarily in rate reset preferred shares. Rate reset preferred shares work by offering a dividend payment that reset a set time period (in this case, five years). The yield is usually based on the Government of Canada bond yield rate plus defined premiums.
Furthermore, ZPR is set up using a laddered strategy, so the preferred shares reset at different times. The smart folks at BMO set the fund up so less than one fifth of ZPR’s preferred shares reset in any year. The laddered strategy is an effective strategy that allows ZPR to respond relatively quickly to changes in interest rates.
The iShares S&P/TSX Canadian Preferred Share ETF, CPD, seeks to replicate the S&P/TSX Preferred Share Index, net of expenses.
Like the other preferred share ETFs, CPD is designed with exposure to a diversified portfolio of Canadian preferred shares and provides a stable regular monthly dividend income.
- Ticker: CPD
- Inception Date: Apr 10, 2007
- MER: 0.50%
- Dividend Yield: 4.32%
- Distribution Frequency: Monthly
- Net Asset: $1,454.6M
- Number of holdings: 226
CPD’s top ten holdings consist of preferred shares from the likes of TD, TC Energy, CIBC, Royal Bank, Enbridge, Bank of Montreal, and Bank of Nova Scotia, all very solid, profitable Canadian companies.
Since CPD tracks the S&P/TSX Preferred Share Index, it has exposure to many different types of preferred shares such as rate reset preferred shares, retractable preferred shares, floating rate preferred shares, and perpetual preferred shares. This is the reason why CPD holds a total of 215 holdings.
The Horizons Active Preferred Share ETF, HPR, aims to provide dividend income while preserving capital by investing primarily in preferred shares of Canadian companies. The ETF may also invest in preferred shares of US companies, fixed income securities of Canadian and US issuers, including other income generating securities, as well as Canadian equity securities and ETFs that issue index participation units.
HPR seeks, to the best of its ability, to hedge its non-Canadian dollar currency exposure to the Canadian dollar at all times.
- Ticker: HPR
- Inception Date: Nov 22, 2010
- MER: 0.64%
- Dividend Yield: 4.35%
- Distribution Frequency: Monthly
- Net Asset: $1,755.6M
- Number of holding: Unknown
Confused about HPR’s fund description? Well, essentially HPR is set up a bit differently than other preferred share ETFs in Canada as HPR holds US preferred shares, fixed income, and even other ETFs.
It’s certainly a more complicated investment structure and selection strategy than other preferred share ETFs available in Canada. As a result, HPR has a higher MER.
HPR holds different preferred share categories. As of writing, HPR holds the following:
- Hybrid: 1.01%
- Fixed-floating: 81.09%
- Floating rate: 1.11%
- Perpetual: 16.8%
The top 10 holdings make up about 17% of HPR and they consist of preferred shares from Canadian banks, Canadian pipeline companies, and Canadian insurance companies.
The RBC Canadian Preferred Share ETF, RPF, seeks to provide investors with exposure to the performance of an actively managed portfolio of rate reset preferred shares issued by Canadian companies, selected on the basis of fundamental analysis, credit research, and interest rate sensitivity analysis.
The fund may also hold preferred shares issued by Canadian companies that are not rate reset preferred shares, fixed-income securities issued by Canadian governments or companies, dividend-paying common stock from Canadian issuers, preferred shares from US issuers as well as other Canadian listed ETFs.
- Ticker: RPF
- Inception Date: Sep 2016
- MER: 0.59%
- Dividend Yield: 4.46%
- Distribution Frequency: Monthly
- Net Asset: $954.0M
- Number of holdings: 187
RPF is the newest preferred share ETF listed in this article. Even though it’s only less than five years old, it has a large net asset. Canadian investors must like RPF to invest their hard-earned money in this ETF.
Given the four Canadian preferred share ETFs, which one is the best to hold? Let’s inspect the key parameters.
ZPR offers the highest yield at the lowest MER. Despite not being the oldest preferred share ETF, ZPR has the largest net asset value.
Although RPF is actively managed, it has a lower MER than HPR. HPR has the highest MER probably because of its complicated ETF structure. I do wish Horizons would disclose the number of holdings that HPR holds so we can compare all four ETFs.
Like broad index ETFs or the all-equity ETFs, it is important to compare sector allocation. However, since all four preferred share ETFs invest primarily in the Canadian market, they are very heavy in the financial and energy sectors.
ZPR has the highest percentages in the other sectors while CPD is highest in financials than the other three ETFs.
Similar to bonds, credit ratings are very important when it comes to preferred shares. There are key three types of credit ratings for preferred shares: P1, P2, and P3.
P1’s are typically associated with companies that have AAA or AA bond ratings. P2’s are associated with companies with A ratings. P3’s are associated with companies with BBB ratings.
There are other lower preferred share credit ratings like P4 and P5 which are used for lower rating companies.
Like bonds, the higher credit rating means these safer preferred shares have lower yields; the lower credit rating means the riskier preferred shares have higher yields.
It’s interesting that the ETF with the highest dividend yield, ZPR, holds the highest percentage of preferred shares in P2 and no lower rating than P3. Meanwhile, HPR and RPF, which are actively managed funds, hold riskier preferred shares, yet do not provide a higher dividend yield.
As an investor, you have to wonder why you would take on extra risks when there is no increase in dividend yield.
Although one shouldn’t expect too much capital appreciation with preferred shares, it doesn’t mean we should ignore performance completely and only focus on dividend yields. Remember, total return is important!
One thing to note is since preferred share ETFs are considered as a hybrid of stocks and bonds, they typically move in the same direction as the stock market (i.e. if the market tanks, preferred share ETF price tanks too!).
However, when interest rates change, the price of preferred share ETFs will move in the opposite direction than the interest rates, regardless of whether it’s a bull or bear market. For example, if interest rates increase, investors want to buy the newer, higher yield bonds and preferred shares, resulting in the old preferred shares decreasing in the share price.
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All four preferred share ETFs have performed well the past year. In comparison, VCN, Vanguard Canada All Cap ETF has a 5 year return of 9.95%.
However, if we look at their performance since inception, they all have done poorly compared to the broad Canadian stock market. For example, VCN returned 8.78% since its inception in Aug 2013.
All four of these preferred share ETFs outlined above are quite attractive. At between 0.5% to 0.64% MER and a dividend yield over 4%, these ETFs may have a place in your investment portfolio.
Should you invest in preferred share ETFs? That’s definitely the million dollar question! For me, I think it greatly depends on your investment timeline and strategy. If you’re like us, still in the accumulation phase, preferred share ETFs may not be the best option for you. You are probably better off investing in common shares or one of the broad market index ETFs, like VEQT.
If you are close to retirement or already retired and you are looking for a stable income source with high yield, preferred share ETFs may be a good option for you. If you fall into this camp, I believe it is way easier to utilize one of these preferred share ETFs rather than holding individual preferred shares. Unless, of course, you don’t mind doing your own research and figuring out which preferred shares to hold in your portfolio.
So, if you want to invest in preferred shares of Canadian companies, which preferred share ETF is best to hold?
Well, for me, I think the BMO Laddered Preferred Share Index ETF (ZPR) is the best one to invest in. This is due to the ETF having the highest dividend yield and lowest MER. On top of that, ZPR holds preferred shares with higher credit ratings. The laddered strategy also makes a lot of sense to me.
Having said all of that, depending on your investment strategy, the other three preferred share ETFs can be good for you too.
Looking for other comparisons? Check out the following articles.
- All-in-one ETFs comparison
- All-equity ETFs comparison
- Top Canadian dividend ETFs
- Top US dividend ETFs
- VXC vs. XAW. The battle of ex-Canada international ETFs
Dear readers, did you find this best preferred share ETFs comparison useful?