What should Canadian investors do: Sell or hold with preferred share losses?

Preferred shares represent less than 5% of the fixed income market. This might imply that holding much more than 5% of your fixed income portfolio in preferred shares is considered an “overweight” (larger investment allocation for a particular asset type).

Preferred shares vs. common shares

Preferred shares differ from common shares. Common shares represent the equity in a company and they go up and down in value primarily based on that company’s profitability. Preferred shares are similar to bonds, but preferred shares rank after unsecured bonds to be paid back in the event of the company going bankrupt.

Unlike bonds, though, which have maturity dates, preferred shares are generally perpetual in nature and do not have a repayment date. In some cases, they may be callable by the company that issued the shares, meaning they can be redeemed at its option.

Preferred shares also differ from bonds because they pay the investors dividends instead of interest income. The dividend rate is typically a set rate like a bond’s interest payment but it may be subject to periodic adjustment. For a taxable investor in Canada holding the asset inside a non-registered account, there’s less tax payable on dividend income than interest income. This is a common reason why investors buy preferred shares in their taxable accounts.

Are preferred shares a good investment?

Preferred shares have done poorly recently, Mario, in large part due to the rises in interest rates.

When rates go up, yesterday’s fixed income instruments paying older, lower rates tend to drop in value. The new, higher yielding investments become more attractive. This applies to bonds and other fixed income instruments like preferred shares.

The 1-, 3-, 5- and 10-year total returns for the S&P/TSX Preferred Share Index through November 30, 2023 were 3.2%, 1.7%, 2.1% and 1.2% annualized. A mutual fund or exchange traded fund (ETF) investor in Canada holding preferred shares would have likely done worse due to the fees.

What are preferred shares?

There are four main types of preferred shares.

1. Rate reset preferred shares

These became popular following the financial crisis in 2008/2009 to entice investors to buy preferred shares despite low interest rates at that time. They generally “reset” every five years with the dividend rate for the next five years based on a premium over the 5-year Government of Canada bond rate at the time. Rate reset preferred shares currently represent 73% of the Canadian preferred share market.

2. Perpetual preferred shares

These represent 25% of the Canadian preferred share market. Perpetuals have no reset date. Their dividend rate is set when they are issued, and they continue in perpetuity.

3. Floating or variable rate preferred shares

These are like rate resets in that the rate changes, but those changes are more frequent—typically quarterly. The rate is generally based on a premium to the 3-month Government of Canada treasury bill rate. Together, floating/variable rate and convertible preferred shares represent less than 3% of the Canadian preferred share market.

4. Convertible preferred shares

A convertible security can be converted into another class of securities of the issuer. For example, a convertible preferred share may be convertible into common shares of the company that issued the shares.

Preferred shares Indexes for Canadian investors

The S&P/TSX Preferred Share Index is currently 57% financials, 20% energy and 12% utilities. Communication services, real estate, and consumer staples makes up the remainder of the market. The financials are tilted slightly more towards banks than insurance companies.

The current distribution yield of the S&P/TSX Preferred Share Index is about 6.1%. This is the dividend income an investor might anticipate over the coming year. The trailing 12-month yield is about 5.9%. These are attractive rates, Mario, but you can earn comparable rates in guaranteed investment certificates (GICs) with no risk or volatility. So, the high yields need to be put into perspective.

What to do with preferred shares at a loss

One consideration, Mario, is if you own your preferred shares in a taxable non-registered account, you could sell them to trigger a loss, if you have other investments that you have sold or intend to sell for a capital gain.

“Tax loss selling” is when you sell an investment for a loss to harvest the tax benefit of that loss. You can claim capital losses against capital gains in the current year. If you have a net capital loss for all investments sold in your taxable accounts in a given year, you can carry that loss back to offset capital gains income you paid tax on in the previous three years. Or you can carry the loss forward to use in the future against capital gains.

My advice, as with selling any investment, Mario, is to start by considering the value of the investment—regardless of the original purchase price. If you had that same value in cash today, would you buy the same investment?

If the answer is no, you should seriously consider selling. If the tax implications of selling are negative (i.e. you are selling for a large capital gain and will trigger tax), that may be a secondary consideration. But, if you are selling for a loss, as is the case for you, the tax benefits are positive.

Be careful about holding onto an investment simply to recover your original capital, Mario. There may be better or more appropriate investments to own that you earn a better or safer return instead. And if you continue to be overweight preferred shares, that could be another reason to sell to diversify and reduce your portfolio risk.

Read more on tax-loss selling:

• ’Tis the season for tax-loss selling in Canada
• What is tax-loss harvesting?
• Selling stocks at a loss in a TFSA: What it means for your contribution room
• Should you sell investments at a loss to pay off debt?

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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