Growing income opportunity from preferred shares?

Forecasts involving two central banks support the case for the recently popular play

Growing income opportunity from preferred shares?
A note from Horizons ETFs suggests that preferred shares could be a profitable investment for those focused on income.

“Preferred shares have been one of the hottest income-focused trades for well over a year now,” said Mark Noble, senior vice president and head of sales strategy at Horizons ETFs. He explained that it’s partly due to a recent rebound in the five-year Government of Canada (GOC) interest rate.

According to Noble, 60% of Canada’s preferred-share market uses the rate-reset structure, which has a coupon that is set every five years at a defined spread over the five-year GOC rate. Because of this, the overall market is generally positively correlated to interest rates, with preferred share values rising as rates go up.

He acknowledged that preferred shares have dipped slightly from their near-term high on April 10, noting that five-year GOC bond yields have dropped to 0.92%.

Citing a rate outlook from Fiera Capital Lead Portfolio Manager Nicolas Normandeau, Noble said the rate decline is likely temporary, “meaning that we could potentially see another nice bounce-back in the five-year rate, which was trading as high as 1.30% in mid-March.”

He supported his case by citing an anticipated June hike from the Fed — a forecast which has proven accurate. Such a Fed rate hike, he said, would likely push the Bank of Canada (BOC) to maintain relative rates with a hike of its own.

Recent statements from both BOC Senior Deputy Governor Carolyn Wilkins and Governor Stephen Poloz have signalled the central bank’s increased willingness to raise Canada’s rate following broad-based gains in the domestic economy.

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