The Preferred Share market was volatile in April with the S&P/TSX Preferred Share Total Return Index (the “Index”) losing 7.04%. Series F of the Lysander-Slater Preferred Share Dividend Fund (the “Fund”) and the Lysander-Slater Preferred Share ActivETF (the “ETF”) lost 7.07% and 7.02%, respectively, on a total return basis.

The 5-year Canada bond yield continued to rise, and reached a high of 2.87% before finishing the month at 2.77%. The Bank of Canada raised the overnight rate by 50 bps to 1%, and is expected to hike another 50 to 100 bps by the end of the summer. Fundamentally, the Canadian economy continues to show strength with the unemployment rate hitting a modern era low of 5.3% in March and WTI crude oil prices continue to hover above U.S $100 per barrel.

Since rising interest rates and strong commodity prices should be good for Canadian Preferred Shares due to their coupon reset features, you may wonder why April was such a weak month for the sector.

We believe that ETF algorithmic selling was responsible for most of the damage. According to Bloomberg, Preferred Share ETFs saw net redemptions of approximately $212 million in March and $172 million in April. This was in comparison to net purchases of $32 million in January and $6 million in February 20221. To facilitate ETF redemptions, ETF designated brokers must immediately sell the underlying holdings regardless of price. In the relatively illiquid Preferred Share world, this type of large scale selling results in high volatility.

The Bank of Montreal called in its $500MM 4.5% fixed reset Preferred Share (BMO.PR.C)2 for cash on May 25, 2022. Our thesis is that the banks (a) will call in their remaining outstanding Preferred Shares at the earliest opportunity, and (b) intend to transition this capital out of retail hands. This process has already begun with the issuance of Limited Recourse Capital Notes and $1,000 par value Preferred Shares to institutional investors only.

In April, we reduced our straight perpetual weighting in both the Fund and ETF from approximately 20% to 15%. We used the cash proceeds to increase our weightings in fixed resets from approximately 70% to 78%. In particular, we used recent weakness to increase the weightings of discounted bank fixed resets where we see favourable risk-reward potential. As mentioned earlier, we believe that bank fixed resets have a favourable probability to be called at the next reset date, and if they were not to be called would still offer an attractive yield-to-reset of 6%-plus at current price levels.

We believe that a combination of rising interest rates and a shortage of Preferred Share product will be positive for performance going forward. We look for ETF selling pressure to subside, and see the pullback in April as an attractive entry point for investors.

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

1, 2. Bloomberg Finance L.P.