In this edition of ‘Stock Teasers’ we are going to be looking at a submission to /r/CanadianInvestor on Reddit where the user is asking if it is worth holding preferred share ETFs. Let’s dive in!

Below we can see the user’s submission where they highlight the mid-term weakness in the iShares S&P/TSX Canadian Preferred Share Index ETF (CPD) and with its recent rally if it makes sense to keep holding.

Source: Reddit

The following graph displays CPD’s performance over a five-year period:

We can see that the user does have a case where CPD has only returned 5% annually over the last five years. CPD had a significant drop from its 2022 highs into the start of 2024 , but it has now fully recovered.

The fundamental price action and returns of preferred shares are quite unique because they share the characteristics of both equity and fixed income investments. For those who are unfamiliar, a preferred share is a class above a common share, with holders having a higher priority claim to dividends and assets in the event of liquidation. Preferred shares typically pay higher yields than common shares, where the dividend payment can be fixed or floating, tied to a benchmark rate. Preferred shares also do not have voting rights, which is a key feature of common shares. There are other differences and numerous types of preferred shares, but the key concept is higher rights to dividends and assets while still maintaining equity ownership.

With an understanding the security itself, preferred share performance is highly tied to the market interest rates, similar to fixed income securities. When rates are increasing, the value of preferred shares typically decreases because they offer lower yields. When rates are declining, the value of preferred shares increase, as they offer higher yields. One important factor is that preferred share prices will typically move on rate expectations rather than the actual rate changes themselves.

So, to address the user’s question, they would be correct in their sentiment regarding rates and the performance of CPD. We can see that as interest rates were aggressively hiked in Canada from 2022 onwards, CPD’s performance declined. Rates had previously been cut due to COVID-19, and CPD reached a price of $14 at the end of 2021. An interesting point brought up by other users was that expectations of future rate cuts are priced into CPD which suggests limited upside. The expectation is that rates will be cut in December so to an extent, this is priced in. However, further cuts are certainly on the table and the economic response will be the determining factor. We think the Canadian economy still has plenty of progress to be made and future rate cuts would help CPD. Additionally, if corporations are able to effectively grow earnings, then the equity features of CPD’s holdings offer more upside potential than a bond ETF.

CPD has done well in 2024, up 19% due to the declining rate environment we have entered. CPD also offers a high yield at 5.25% so we see the potential in holding it in the short-to-midterm as it offers both income and a some growth upside.

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