BY: MARK NOBLE, SENIOR VICE-PRESIDENT, ETF STRATEGY, HORIZONS ETFS
December 22, 2017
The Horizons Active Preferred Share ETF (HPR) recently exceeded the $1.5 billion mark in assets under management (“AUM”), surpassing the iShares S&P/TSX Preferred Share ETF (CPD) – making HPR the second-largest preferred share ETF in Canada.
CPD was the first preferred share ETF launched in Canada and seeks to replicate the most widely followed preferred share benchmark in Canada – the S&P/TSX Preferred Share Index. So what has driven many investors to choose HPR over the CPD? We believe it’s the well-established performance benefits of using professional active management to select preferred shares.
“Most preferred shares should continue to provide an attractive mix of tax-efficient income and strong price returns in 2018,” says Nicolas Normandeau, Vice-President and Portfolio Manager, Fixed Income with Fiera Capital Corporation (“Fiera Capital”) and the lead manager on HPR.
The recent rally in rate-reset preferred shares (which was largely ignited by a rise in the five-year government of Canada rates – the baseline yield for rate-reset preferred shares) does not appear to have been fully realized by index strategies. We believe there is limited value in owning rate-reset preferred shares that trade at a premium at this point in time, beyond purely speculating on the possibility that they will continue to rise over the short term.
Intuitively, investors who actively select preferred shares tend to avoid these issues because they often have a built-in loss, particularly if they have a call feature that would allow the issuer to call them in at a discount to their market value.
Despite having a much lower allocation to rate-reset preferred shares, HPR has outperformed index strategies year-to-date (see the performance chart below) which we see as primarily due to one key advantage – security selection – more specifically, avoiding rate-reset preferred shares that trade at a premium.
Performance of Established Canadian Preferred Share ETFs
Floating Rate Preferred
Share ETF (HFP)
Share Index ETF (CPD)
Source: Morningstar Direct, as at November 25, 2017.
The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the ETF or returns on investment in the ETF. The index is not directly investable.
According to Nicolas Normandeau, there are other significant reasons to consider HPR over index strategies for preferred share exposure.
1. Active Management/Credit Analysis: Index ETFs do not undertake any independent credit analysis or interest rate outlook. Index strategies must replicate, to the extent possible, their underlying benchmarks and buy most if not all of the underlying constituents of the index, regardless of the relative valuations or liquidity.
HPR is not tied to an index. Fiera Capital undertakes independent credit analysis on all issues. The team at Fiera Capital is a corporate credit team, and manages tens of billions in corporate credit alongside their preferred share holdings. As a result, HPR is not forced to buy weaker credit issuers.
2. Interest Rate Outlook: If Fiera Capital thinks rates could continue to increase, they will add discounted fixed reset or floating issues to the portfolio. On the flipside, if they think rates could decrease, they will buy a fixed rate perpetual. HPR can hold up to 10% of cash or up to 20% in investment-grade bonds. HPR can also buy foreign preferred shares (up to a 20% allocation) for diversification. This flexibility allows HPR to pivot if the market dramatically changes, as it did in 2015.
3. Rebalancing: HPR is not tied to fixed date rebalancing like index strategies. The Canadian preferred share market remains relatively shallow in terms of liquidity. When a huge index asset pool has to rebalance its exposure, it gets grinded by the secondary market. HPR is not forced to buy or sell any issues on a fixed date and in some cases it can also take advantage of the price dislocation that occurs when index ETFs rebalance.
4. Similar Fees: HPR has a management fee of 0.55% (plus applicable taxes); this is only slightly higher than competitor index ETF fees (plus applicable taxes).
General Investment Objectives
HPR: Seeks to provide dividend income while preserving capital by investing primarily in preferred shares of Canadian companies. The ETF may also invest in preferred shares of companies located in the United States, fixed income securities of Canadian and U.S. issuers, including other income generating securities, as well as Canadian equity securities and exchange traded funds that issue index participation units.
HFP: Seeks to generate income consistent with prevailing short-term preferred share yields while stabilizing the market value of the ETF from the effects of interest rate fluctuations. HFP invests primarily in preferred shares of Canadian companies and may also invest in preferred shares of companies located in the United States, fixed-income securities of Canadian and U.S. issuers, including other income generating securities and listed funds. Horizons HFP will generally maintain a portfolio duration of less than two years. HFP may use derivatives, including interest rate swaps and futures contracts, to contribute to the ability of the ETF to seek to deliver a floating rate of income.
CPD: Seeks to replicate the S&P/TSX Preferred Share Index, net of expenses.
ZPR: Seeks to replicate, to the extent possible, the performance of the Solactive Laddered Canadian Preferred Share Index (the “Index”), net of expenses. The Fund invests in and holds the Constituent Securities of the Index in the same proportion as they are reflected in the Index.
Certain statements may constitute a forward looking statement, including those identified by the expression “expect” and similar expressions (including grammatical variations thereof). The forward-looking statements are not historical facts but reflect the author’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward looking statements. These forward-looking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law.
The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.