In the previous post, we looked at the capital shares ( DFN) of the Dividend 15 Split Corp., which pay a dividend of 11% (I will likely have more info on these shares in a future post). In this post, well take a bit of a detour and look at the preferred shares ( DFN.PR.A) of Dividend 15 Split Corp.
The preferred shares:
- have a wind-up date
- have priority claim(>capital shares) on the funds assets at windup
- non-callable (never forced to give up shares for less than par value).
- do not benefit from any growth in the underlying stocks
- price tends to be steady
- investors have a monthly/annual redemption feature
Holders of the preferred shares receive fixed, cumulative monthly payments based on the dividends received from the stocks in the underlying basket. These payments are usually in the form of eligible Canadian dividends, which are taxed at a lower rate than other types of income. The yield to maturity is close to 5%.
I asked preferred-shares expert James Hymas of Hymas Investment Management Inc. what he thought of the shares. In sum, he concluded they would make an excellent substitute for GICs, which pay 2% on the five year maturity. Here is his analysis, as astute as ever:
The preferreds are well secured, with each $10 preferred share backed by about $19 in stock of mostly blue-chip Canadian corporations (although heavy on the financials). Income coverage in 1H09 was a very healthy 1.4:1.
At the current bid of $10.15, they have a quarterly-compounded yield-to-maturity of about 5%; this is as dividends, equating to about 7% as interest.
Investors should not be overly concerned about the credit rating of only Pfd-3(high) – DBRS considers only the potential for default and makes no allowance for recovery after default, which may be expected to be much higher for split share corporations than for ordinary corporations.
With the five year term, they make an excellent substitute for five-year GICs, which now yield about 2%, equivalent to about 1.4% dividend. If we assume that DFN.PR.A makes all its scheduled dividend payments, but defaults on principal, then the total return will exceed 1.4% provided that the recovery of principal is in excess of about $8.15, implying that as far as this comparison is concerned, the underlying portfolio may decline by more than 50% and still beat GICs on a total return basis.
You wouldn’t want to bet the farm on it, but a modest position in DFN.PR.A will add a little zing with modest additional risk to a short term fixed income portfolio.
I regularly recommend short-term preferred share investments in my monthly newsletter, PrefLetter– DFN.PR.A did not make the cut this time.