Strong performance by rate reset issues propelled the S&P/TSX Preferred Share index to a robust 2.84% return in June. Rising bond yields led to increased buying interest in rate reset shares, but growth in preferred share Exchange Traded Funds (ETFs) were also a factor. Approximately $260 million of new deposits flowed into the largest ETFs, with the BMO Laddered Rate Reset ETF (ZPR) receiving $144 million and the Horizons Active Preferred Share ETF receiving $56 million. Interestingly, the growth in ETFs occurred while institutional interest in preferred shares appeared to decline.
A key development for Canadian markets in June was an abrupt policy shift by the Bank of Canada (BOC). After two years of defending its 2015 rate reductions and deflecting blame for the resultant housing bubbles in Vancouver and Toronto, the BOC’s Senior Deputy Governor, Carolyn Wilkins, gave a speech on June 12th, strongly hinting the BOC was considering raising interest rates, saying the economy no longer required the current extraordinary stimulus. Subsequent statements by the BOC’s Governor and other officials reinforced Wilkins’s message. Bond yields, particularly for shorter maturities, moved sharply higher over the balance of the month as investors discounted the possibility of a rate increase as soon as the BOC’s July 12th meeting. 5-year Canada bond yields rose 42 basis points in the month, to the highest level since prior to the BOC’s first surprise rate reduction in January 2015. The jump in 5-year bond yields prompted a rally in rate reset preferred shares, particularly those issues scheduled to rollover in the next year, as their respective dividend rates would now be reset off a higher base.
There were only two new issues in June – National Bank and Bank of Montreal. Both deals were priced somewhat aggressively and, therefore, could not be increased to sizes close to some other recent bank issues. Details of the new issues were as follows:
The breakdown between institutional and retail participation in the two new issues was noteworthy. In recent months, institutional investors had been purchasing 50% to 60% of most new issues. In June, the institutional investors were far less interested in adding to their preferred share holdings. We believe many factors accounted for the drop in institutional interest. One reason was that short-term bond yields rose sharply because of the selloff in global bond markets. As a result, the yield advantage of preferred shares shrank, making them less attractive. Another reason was that recent new issues have not immediately moved to premiums, leading some “hot money” investors to move on to other types of investments. A third factor behind the reduced interest may have been the lower reset spreads, which make it more difficult to anticipate whether the issue will be extended or redeemed in five years. The greater uncertainty may have discouraged some buyers.
Extending the trend of recent months, there was insufficient interest in the floating rate option for the respective floating rate series to be created when four rate reset issues reset their dividends in June. All the outstanding shares of BAM.PR.X, CF.PR.C, IAG.PR.G, and TA.PR.F will continue to have fixed dividend rates for the next five years. We note that all four issues required shareholders to make their fixed or floating election by June 15th, so the timing of the BOC’s policy shift was likely too late to influence the preferred shareholders’ decision. Going forward, though, we expect more shareholders will elect to take the floating rate option given the potential for multiple rate increases in the coming years, and the relatively small differential between floating and fixed rate dividend rates at present.
A month ago, we reported that Aimia preferred shares had fallen in value following the news that Air Canada would not be renewing its Aeroplan contract with Aimia. In June, the preferred shares plunged again because the company suspended the dividends on both its preferred and common stock due to an uncertain business outlook. As we noted last month, we had avoided Aimia preferred shares, because of credit quality concerns.
Natixis Canadian Preferred Share Fund
The Fund held relatively fewer rate reset issues and more perpetual issues, and that mix lagged the index last month.
The Fund participated modestly in the new NA.PR.C issue to reduce cash levels. Other purchases consisted of additions to existing holdings. The balances of the TD.PF.A and TD.PF.H were sold because they were fully valued. We also trimmed the Pembina Pipeline holdings following its takeover of Veresen Inc. to reduce corporate concentration.
Market Outlook and Strategy
Considering the BOC’s hints during June, it seems highly likely that it will raise interest rates by 0.25% at its July 12th meeting. There is little reason for the BOC to start preparing the market for a rate increase in the fall, so we believe its intention was to move sooner. Another rate increase in the fall would fully reverse the BOC’s 2015 rate cuts and we expect that the BOC will then pause to evaluate the impact of the rate increases and to avoid catching up to the Fed’s 1.25% target rate. We think the Fed will skip raising rates again at its September meeting, and choose to start reducing its balance sheet instead.
The adjustment in yields following the BOC’s policy stance has made short- and mid-term bonds more reasonably priced. 5-year Canada bond yields have risen close to 1.50%, which appears to fully discount for the two rate increases that are expected over the balance of 2017. We think further increases in bond yields will be drawn out, thereby reducing support for further, immediate price improvement in rate reset issues.
We remain optimistic for preferred shares over the balance of the year. Notwithstanding the rise in bond yields during June, preferred share yields are substantially higher than bond yields making them attractive to yield-oriented investors. With Canadian economic growth expected to be good over the next 12 to 18 months, the preferred share market should gradually produce gains to augment dividend yields.
For more information about Natixis Canadian Preferred Share Funds, please contact your financial advisor.
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This release may contain “forward-looking statements” which reflect the current expectations of NGAM Canada LP and/or its sub-advisor, J. Zechner Associates Inc. (“J. Zechner”). These statements reflect the applicable management’s current beliefs with respect to future events and are based on information currently available to such management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements including, without limitation, those listed under the heading “Risk Factors” in the NGAM Canada LP Funds prospectus, which is available on NGAM Canada LP’s website and on SEDAR at www.sedar.com. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this release. Although the forward-looking statements contained in this release are based upon what NGAM Canada LP and/or J. Zechner believes to be reasonable assumptions, NGAM Canada LP and J. Zechner cannot assure investors that actual results, performance or achievements will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this release and NGAM Canada LP and J. Zechner do not assume any obligation to update or revise them to reflect new events or circumstances.
NGAM Canada LP is the manager of the Fund and is an affiliate of Natixis Global Asset Management S.A.