The Canadian Preferred Share market had another strong quarter in Q3 with the S&P/TSX Preferred Share Total Return Index (the “Index”) up 5.5% in the quarter, and 20.5% year-to-date as of September 30, 2024. Series F of Lysander-Slater Preferred Share Dividend Fund (the “Fund”), and Lysander-Slater Preferred Share ActivETF (the “ETF”) were up 4.7% & 4.6% in the quarter, and are up 19.8% year-to-date as of September 30, 2024 respectively, on a total return basis.
The Bank of Canada (“BoC”) cut the overnight rate 25bps twice to 4.25%, and the U.S Federal Reserve (“Fed”) had their first interest rate cut since March 2020 with a 50bps cut putting the overnight rate in the range of 4.75% – 5%. As a result, the CAD 5-year bond yield fell to 2.75% at the end of Q3 which was 85bps lower than where it was to begin the quarter.
Several factors contributed to further strength in Preferred Shares despite interest rates dropping which negatively affects the future dividend rates on fixed-rate resets and floating rate Preferred Shares. Firstly, approximately $2.84 billion of Preferred Shares were redeemed for cash in the quarter leading to investors reinvesting some of those proceeds back in the secondary market. Secondly, investors flocked into fixed income investments as evident through the strength in longer term treasury bonds with central banks cutting rates. Preferred Shares provide an attractive yield alternative to bonds with over half the fixed-reset market resetting in the higher interest rate environment since early 2022 (Many of which now yield over 7%).
Our expectation for all bank Preferred Shares to be redeemed upon their next reset date took a surprising turn with TD announcing that they would not redeem their $500MM 224bp (“TD.PF.A”) fixed-rate reset due at the end of October, and will be extending for another 5 years. Currently, we are not sure if this is a bank specific call or if other banks will follow suit and choose not to redeem their lower spread resets of 220-230bps.
Despite TD not calling in their TD.PF.A issue this go around we still firmly believe that all listed bank issuance will eventually be phased out and converted into over the counter Limited Recourse Capital Notes (“LRCN”) and $1000 Par Preferred Shares (“$1K”). We’ve also performed our own market volatility analysis on the $1000 Preferred Share market and have noticed that since inception many issues have shown to have very attractive sharpe ratios relative to tradition bank Preferred Shares. As such, we’ve increased the weighting for the Fund and ETF in the $1K market from 18% at the beginning of the quarter to 30%.
Heading into Q4 we expect for the Bank of Canada and U.S Fed to continue to cut interest rates which may continue to put some pressure on the CAD 5-year bond yield. However, as mentioned over half of the Preferred Share market has been reset with the 5-year bond yield being above 2.7% allowing resets to have current yields between 5.5%-10%. The high yield that many Preferred Shares offer will continue to support the market as investors continue to seek for yield in a falling interest rate environment. The risk to our outlook is that a severe recession occurs, resulting in extreme downward pressure on bond yields and financial markets in general.