Slater Canadian Preferred Share Market Recap – December 2022

Tax-loss selling of Canadian Preferred Shares persisted in December. As a result, the S&P/TSX Preferred Share Total Return Index (the “Index”) lost 1.75% in the month, and finished the year down 18.08%. Similarly, Series F of Lysander-Slater Preferred Share Dividend Fund (the “Fund”) and Lysander-Slater Preferred Share ActivETF (the “ETF”) lost 1.34% and 1.17%, respectively, to finish the year at -18.44% and -18.36%, respectively, on a total return basis.

After posting its strongest performance in history in 2021, the Canadian Preferred Share market posted its worst performance in history this year despite a bright forecast. Our expectations for gradually rising interest rates and high redemption activity were thought to be a recipe for success for 2022, as they had been in the prior year.

However, equity and bond market performance were rocked by war and hyper-inflation in 2022. A ban on trade with Russia caused the WTI crude oil price to spike to as high as US $120 p/b, and food prices to soar. Under pressure to bring inflation under control, Central banks began aggressively raising interest rates. By the beginning of June, the 5-year Canada bond yield was up to 3.10% compared to 1.60% where it started the year. The rapid pace of rate hikes, along with widening credit spreads, resulted in issuers having to price new issues generously. Those richly-priced new issues put downward pressure on market prices of existing issues.

To put it into perspective, Royal Bank issued a Limited Recourse Capital Note (“LRCN”) in June 2021 with a 3.65% coupon, which was a credit spread of 265 basis points over the 5-year Canada bond yield. One year later, in July 2022, TD Bank issued a $1000 Preferred Share with a 7.23% coupon, which represented a credit spread of 420 basis points.

Illiquidity proved to be problematic throughout the year with so many retail investors and non-traditional Preferred Share fund managers exiting the sector. According to Bloomberg, Preferred Share ETFs had their worst year for redemption activity with approximately $1.23 billion in net redemptions. To facilitate ETF redemptions, ETF designated brokers had to immediately sell the underlying holdings regardless of price. In the relatively illiquid Preferred Share world, this type of large-scale selling resulted in high volatility.

Today, the Preferred Share market offers attractive value. We believe that performance in the sector will improve as interest rates stabilize. The 5-year Canada bond yield finished the year at 3.40% which, in our opinion, is around the sweet spot for the rate-reset sub-sector. To take advantage of this renewed value, we have increased our exposure to rate-resets, in both the Fund and ETF, to 82% (all at a discount). We have also increased each of the Fund’s and ETF’s floating-rate position to 2.5%. Our focus is to add to rate-resets that will reset in 2023 and 2024 that offer attractive yields-to-reset. Both the Fund and ETF hold an approximate 10.3% weighting in 2023 resets, 19.4% in 2024 resets, and 38% in 2025 resets. 

Looking forward, our expectation is that the Preferred Share market can perform well in 2023 as long as a severe recession does not occur. In the past 15 years, the Canadian Preferred Share market has had five negative performing years. Each of those years was followed by a year of positive performance. The last time this was evident was the period between 2008 and 2009. In 2008 the S&P/TSX Preferred Share market finished down 16.85% on a total return basis and was followed up with a total return of +26.97% in 2009. We believe that positive returns for Canadian Preferred Shares are achievable in 2023.

As an active manager, we continually seek out the best opportunities in the Preferred Share market for our investors based on market conditions.

Lysander Funds Limited (“Lysander”) is the investment fund manager of Lysander-Slater Preferred Share Dividend Fund and Lysander-Slater Preferred Share ActivETF (collectively, the “Funds”). Slater Asset Management Inc. (“Slater”) is the portfolio manager of the Funds. This document was prepared by Slater as portfolio manager of the Funds. In this document, “we”, “us”, and “our” means Slater. This document has been prepared solely for information purposes. Information in this document is not intended to constitute legal, tax, securities or investment advice and is made available on an "as is" basis. Neither Lysander nor Slater make any warranties or representations regarding the information herein. Information in this document is subject to change without notice. Neither Lysander nor Slater assume any duty to update any information herein. Certain information in this document has been derived or obtained from sources believed to be trustworthy and/or reliable. Neither Lysander nor Slater assume responsibility for the accuracy, currency, reliability or correctness of any such information.
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