Saturday, 25 December 2010

Borrowing to Invest (Leverage) - Choosing Amongst Loan, Margin, Leveraged Fund, Capital Split Shares

Interest rates are low these days so some investors might be considering borrowing money to invest. The first step is to carefully consider the rewards and risks of borrowing money to invest, also referred to as using leverage. Doing a Google search for the words "borrowing to invest" along with "leverage" will bring up many articles. It's highly advisable to read several before jumping in.

Once the decision has been taken, the next step is choosing a method. Let's explore the pros and cons of three common ways to use leverage for buying stocks in Canada - 1) Bank loan, secured or unsecured, 2) Broker Margin, 3) Leveraged ETFs - and one less known method - 4) Capital Split Shares.

1) Bank Loan / Line of Credit
  • Loan interest must be paid regularly on a fixed schedule, and perhaps principal payments too, unless the loan is interest-only
  • Payments do not vary with value of the investments, whether they go up or down, unlike margin with its possible margin calls. Close monitoring of the investments is not required.
  • Full amount of the investment can be covered by the loan
  • Loan collateral may be none, if unsecured, provided by the securities, or by other assets, like a home. That can have drastic consequences if the investments go bad and you cannot pay the loan. A key pre-requisite to choosing this method of leverage would have to be the investor's capacity to keep paying the loan despite stock market dips.
  • Investment choices are unlimited.
  • Current unsecured loan interest rates are in the 5-6% range according to Fiscal Agents. One should then net out the tax deduction of interest in a taxable account - at 46% top marginal rate in Ontario, that works out to 5% - 0.46*5% = 2.7%. Secured (against a home or the investments) rates would be about 1% less, around 4%. These are floating rates that will rise when interest rates do. Fixed rate term loans are available but the cost will be much higher. One major bank is quoting 8.55% for a two-year term loan.
2) Broker Margin
  • Interest rate fluctuates up or down with prime rate. Borrowing cost is not fixed or predictable
  • Investor must put in some equity money, calculated as a percentage of the total investment e.g. 30%. That percentage must be maintained at all times. If the market goes up, there's no problem but a market decline may push the value of the investments too low compared to the loan and the investor will then receive a margin call to add cash to the account or be forced to sell some of the securities
  • Loan collateral is provided by the securities
  • Amount of margin or equity that the investor must provide varies by stock price e.g. for stocks priced at $5 or more, the investor must put up a stake of 30% of the total investment while it is 50% for stocks $2 to $5 and under $2, it is not possible to buy on margin at all. Beyond that, investment choices are unlimited.
  • Margin accounts are normally only available for taxable accounts, not TFSAs, RRSPs or other registered accounts. In any case, losing the tax deductability of the interest expense, which happens when funds are borrowed for investment within registered accounts, knocks off a big part of the value of borrowing to invest.
  • Interest is paid through monthly posting by the broker of the charge in the account (see BMO's FAQ). If the account has a cash balance, the interest will be deducted against the cash, otherwise it is cumulated and compounded monthly with the rest of the margin loan and figures into the margin maintenance calculation.
  • Cost of borrowing - A typical current broker margin rate is 4.25% such as at BMO Investorline, though it may be less for larger accounts One should then net out the tax deduction of interest in a taxable account - at 46% top marginal rate in Ontario, that works out to 4.25 - 0.46*4.25 = 2.38%.
3) Leveraged ETFs (see primers such as ETFdb's and GetSmarterAboutMoney's)
  • Fund applies the leverage, not the investor. The ETF determines the amount of leveraging, not the investor. Most ETFs are 2x leveraged to get double the underlying stock return though some US ETFs apply 3x leverage.
  • Due to leveraging techniques used, such as options and futures, the investor gets no tax deductible interest charge. Investors will generally experience only capital gains or losses from buying or selling the ETF shares.
  • Daily performance tracking of such ETFs - it is the daily return only that the ETF enhances - means that they are suitable only for short term trading and not for long term investing.
  • Broad range of index and sector tracking funds is available.
  • Eligible to be bought in any type of account
  • Costs are difficult to determine or predict due to the mix of management fees (the only Canadian leveraged ETF provider Horizons BetaPro funds charge 1.15%) and on-going leveraging costs. Price performance of the ETF shares will almost always overwhelm such costs in determining investment returns.
4) Capital Split Shares (see our recent post looking at their overall investment potential)
  • Borrowing is carried out by the split share corporation, not the investor. Thus, amount of leverage is not controlled by the investor. Most split shares employ less than 2x leverage, many much less than that. To find out exactly how much, one must go to the split share's website and either get it from the corporation's profile or from the annual report. For instance, Newgrowth Corp (TSX symbol: NEW.A) sports leverage of 1.52x (52 cents of debt for each equity dollar invested)
  • Investor faces no loan repayments or margin calls. The collective "loan" consisting of the preferred shares in the split share corporation is only paid back at its wind-up maturity date (June 26, 2014 for NEW.A). As an investor, you merely hold the shares and experience up or down movements in stocks as paper gains or losses until they are realized upon sale. The Capital share will merely(!) decline a lot faster than the market but you won't be required to come up with extra cash.
  • No tax-deductible interest arises from owning split shares. Distributions are in the form of dividends or return of capital.
  • A limited range of investment opportunities through split shares exists in Canada - mainly large banks, insurance companies, utilities, REITs, telecomms, pipelines. The majority have multiple holdings, a few are fairly diversified and some hold the shares of only one company. The 50 or so Canadian split share corporations are listed within the GlobeInvestor Closed-End Fund report.
  • Total cost of borrowing is the sum of the preferred share interest rate plus other corporate expenses. For example, for NEW.A, we estimate costs at 6.45% - the sum of preferred dividends receiving 6.0% plus other fund costs 0.45%. The cost remains quite static. The main component, the preferred share dividends, remains fixed through out the the life of split share corporation and the other expenses should not vary a great deal. Interest rates these days are quite low but if, or should we say when, they start to rise the fixed borrowing rate costs of existing Split Shares will become increasingly beneficial to Capital shareholders.

This quick review of the options for leveraged investing suggests that the best method might vary amongst investors depending on many factors, such as type of account, tax situation, financial flexibility, target securities, time horizon and risk capacity. Hopefully, this post helps you to be aware of the alternatives and some of their key characteristics.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Wednesday, 22 December 2010

Split-Share Corporations - Christmas Bargains Amongst Capital Shares?

A few weeks back we looked at Split Share Preferreds for potential good investments offering steady, safe, attractive dividend income. Today we examine the counterpart to those preferreds, the Capital shares issued by Split Share Corporations. Capital shares are completely different - their appeal is primarily for investors who seek capital appreciation, not income. Let's look at how they work, discuss their pros and cons and then compare some of them whose preferred shares we examined.

Key Features of Split Capital Shares:
  • Capital Shareholders are residual owners of the Split Share Corporation, taking lower priority after Preferred Share obligations are met.
  • Capital Shareholders are obliged to pay all the professional management and other fund costs (fund managers to run the portfolio, do all the accounting, meet legal and regulatory filing or tax requirements, decide and pay distributions, pay out retractions, decide on redemptions etc),
  • Since the Capital shares receive all the dividends coming from the common shares in the portfolio, they can benefit from any dividend increases of the holdings. In many Split Share portfolios, banks occupy a prominent place and until recent times, they have given off steady rounds of increases. A key question for the prospects of all Split Capital shares is whether the banks will resume dividend hikes with recovery from the credit crunch and recession. During the recent hard times, dividend cuts by the companies within portfolios have eaten into the cash flow received by the Split Corporations, which are still responsible to pay the unchanged preferred dividends. This has hurt the Capital shares.
  • Their use of leverage (borrowed money) increases volatility and risk of the returns. The aim is to boost returns but it can increase losses too. The leverage comes from the preferred shares. The "borrowing rate" is the fixed preferred dividend yield and the "amount borrowed" is the redemption value that will be paid back to preferred owners at the pre-set termination date of the Split Share Corporation. Unlike leveraged ETFs which are not suitable for long term investors due to their daily rebalancing, Capital Split shares with their infrequently re-balanced portfolios are much more suitable for the long term hold investor. The amount of leverage varies amongst the various Split Share Corporations but is always appreciably below 2x for the high quality issues we look at. However, even among the more conservatively managed Split Share Corporations which we have chosen to examine, the effect in the 2007-2008 crisis has in some cases been quite harsh. Note in the chart below from TMX Money of five-year prices for our Split Capital shares how the blue line of the S&P/TSX 60 Index decline through 2008, bad as it was, is dwarfed by the Splits' vertiginous falls. Several Split Capitals have never recovered up to the benchmark Index.
  • Lack of liquidity for Capital shares is typical, as very low trading volumes can make it difficult to sell or buy shares at a reasonable price. Our comparison table shows Split Capital trading volumes of a few thousand shares per day at most and large spreads between bid and ask market prices. The market price often diverges widely from fair value (Net Asset Value) unlike most ETFs, where mainstream fund market prices rarely exceed +/-1% of NAV. Poor liquidity also means that it may be difficult to carry out arbitrage to take advantage of retraction clauses by buying up shares trading well below NAV and then tendering them to the Split Corp to receive the NAV price.
  • Retraction rights form part of every Split Share. Details vary in small but crucial ways, which has a significant effect on the feasibility of arbitrage action to take advantage of apparent mis-pricing. Retraction rights allow the Capital shareholder to submit shares back to the Split Share Corporation for reimbursement at Net Asset Value (NAV) or some discount to NAV. In several Split Corporations, the investor wishing to retract must submit a combination of a Capital Share and a Preferred Share, termed a Unit. That means being required to buy one of each in the market. In a couple of cases - BBO and CFS - a pricing discount for Capital shares is partly or mostly offset by a premium on the Preferreds such that retraction offers less potential arbitrage profit.
  • Sector concentration or lack of diversification of holdings affects most Split Share Corporations, increasing risk. Big banks and insurance companies form the core of most Split Share portfolios and the woes of the financial sector in recent years have hit returns and capital values hard.
  • Capital shares have no direct ownership rights or voting rights to the shares in the portfolio. That is a weaker/riskier position than being a common shareholder in a normal corporation.
  • Some Split Corporations engage in covered option writing to generate more revenue and increase returns but that has a bit of added risk as well.
Comparison - Split Capital Shares with a Diversified Portfolio
(click on table image to enlarge)

  • Brompton Equity Split Class A (TSX symbol: BE) - This is an actively managed fund with mainly Canadian and some US stocks whose managers have picked right recently with a one-year price advance of 11.4%, beating the S&P TSX 60 Index return of 10.5%, while also providing an extremely high 9.7% distribution yield. This yield has evidently been achieved by distributing its unrealized capital gains through Return of Capital, against which no tax is payable. Meanwhile its market price still trades at a 5.6% discount to NAV. There appears to be a trading opportunity with BE since the fund termination date is less than six months away and NAV will be paid out to shareholders then. However, BE's leverage is relatively high 1.87 so buying a share could still produce a loss - remember, leverage amplifies losses as well as gains - if the stock market heads downwards before May. The chart below from TMX Money of the one-year price performance of our Split Capital shares illustrates this well. Note how much more the black line of BE dipped during the summer compared to the blue line of the TSX index
  • Sixty Split Corp (SXT) - This fund's policy is to passively mimic the S&P TSX Index, except that it adds a modest amount (1.17) of leverage. As result, its price is less volatile than BE's and the chart reflects this - see how much the brown line of SXT stays much closer to the blue line of the TSX Index. SXT has a small discount to NAV of 3.0% but its termination date is upcoming soon in March. However, it pays no distribution while the TSX Index pays about 2.5%. Its one-year return of 17.2% has outstripped the TSX Index's 13% total return (price increase plus dividend).
  • Big Bank Big Oil Split Corp (BBO) - This is the least diversified of our Split Corp line-up with only bank and energy company holdings. The result of sector concentration shows up in poor one-year price returns - a 2.2% loss - compared to the 10.5% price gain of the TSX. The loss is offset by a hefty 8% distribution yield. For the future, BBO will be continually hampered by the highest total costs in our set of funds, a total of 7.25%. Even the 6.1% discount of market price to NAV doesn't help much since termination is six years away.
  • Canadian Financials and Utilities Split Corp Class A (CFS) - This is an unusual fund in that it currently uses no leverage at all. Due to its forced de-leveraging formula to protect the highest Pfd-1 rating on preferred shares, in the 2008 crisis the Capital Class A shares got hammered and CFS reduced its leverage to zero. The distribution on Class A shares was eliminated and there still is none. There will likely not be any distributions either before the fund termination in 2012 since the NAV would have to rise over $7.37 from its current $5.54 and there is a low chance (i.e. of another 33% rise in the stock market before 2012) of that. Nowadays, the return of CFS' NAV will track very closely that of the TSX 60 Index. CFS has little investment attraction until we notice that its market price is a whopping 17.5% below NAV. With only two years to go to wind-up and the payout of NAV on a Class A share, if the market merely remains flat, there is a possible gain. Even in a flat market, one must deduct about 2.6% annual loss (5.2% for two years) from operations since common dividends received from the fund portfolio and interest on cash deposits only cover about half the 5.2% total expenses of CFS. As investors, we must ask ourselves whether it is worth tieing up money for two years to get a possible 12% or so gain (17.5% - 5.2%). If markets go up or dividends rise, such an investment in CFS will do better as NAV rises. If markets go down again, we would do worse as further NAV capital losses would be reinforced by more portfolio selling to protect the preferred payouts.
  • NewGrowth Corp (NEW.A) - This is a middle of the road fund with moderate leverage (1.62), a reasonable size (15-20) and variety (utilities, telecomms and banks) of holdings in its portfolio and distribution yield (2.4%) similar to that of the TSX 60 Index. Its recent market price is a large 10.1% discount to NAV and its annual retraction clause is the best possible for a Capital share investor. The clause requires only submission of a Capital share to receive its NAV and it is the preferred issue/redemption price that is used, so we do not need to worry about the preferred share market price. That may well be worth the wait till the June retraction date to get a potential trading profit if the market price does not recover to NAV and the overall market does not fall.
Bottom Line: BE, CFS and NEW.A all offer possible trading profits over the next 3 to 36 months if the market and especially financials go up or stay at least flat. For the longer term, a similar replacement for the soon-to-expire SXT will be attractive to those who seek amplified returns of leverage and who think the market's direction is upward, or at least not due for a 2008-equivalent crash downwards.

Whether these shares are on your last minute Christmas shopping bargain list or not, best wishes to all readers for an enjoyable holiday with family and friends!!

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 14 December 2010

Proposed US Tax Deal Offers Relief for Canadian Investors

You may not be a US citizen, you may not reside in the USA or you may not even set foot in the country but if you have US assets including stocks, bonds, ETFs or other securities, you may be liable for US estate tax. Many Canadian investors are not aware of this reality, though they should be, especially if the Obama-Republican tax deal with its provision for US estate tax falls through. The prospects for the deal are changing daily and news reports suggest it is not at all a sure thing. However, US estate tax law will apply no matter which way the tax deal goes since a law is already in place. The Obama deal modifies the law in a way that substantially benefits Canadian investors so it well worth examining the situation.

Why Canadians Should Worry About US Estate Tax
US estate tax rules apply to anyone (i.e. including non-citizen, non-residents) with US assets whose worldwide estate (i.e. US assets and non-US assets, which includes investments outside or inside registered plans like TFSAs, LRIFs, LIRAs, RRSPs etc) exceeds the exemption amount. The catch, and the reason for the current anxiety amongst many people, is that a 2001 law progressively raised the tax-exempt total from US$1 million to a point of complete repeal of estate taxes in 2010 but it reinstates the low 2001 exemption limits as of January 1, 2011. It may seem that $1 million is quite a high total affecting only a few rich people until we realize that the US estate tax law defines a very broad range of assets to tally up the worldwide estate, some of which are not subject to tax at all in Canada. Most notably, that includes a principal residence and proceeds of life insurance.

On top of that, the US estate tax is applied against the value of the US-situated (and not, thankfully, against a non-resident alien's worldwide estate) assets, in contrast to Canada's tax system, where deemed disposition rules result in only capital gains being levied on assets at death. The result is possible hefty tax amounts to pay to the US upon death even if there has been no gain on the US investments. People in retirement and those later in life probably have most cause to worry about this but anyone who has amassed substantial assets needs to pay attention.

The Obama proposal sets the tax exempt amount at US$5 million worldwide assets and the top marginal estate tax rate at 35% according to this news report. The proposed estate tax change is not specifically targeted to foreigners or Canadians since US citizens are affected too, but it is good news as it would exempt most Canadian investors. The maximum tax rate is much lower as well.

Failing the tax deal going through, the 2001 rates will apply. To see the effect that might have, we work through an example using the rates cited in the Wikipedia article Estate Tax in the United States (we caution that though we believe the rates to be correct, to be sure you should consult a qualified tax professional). Our investor is assumed to have a US$2 million estate, of which US assets are US$250,000. By the 2001 rules, he/she would be liable for $27,575 in US estate taxes as shown below. Under the Obama deal, the $2 million is well below the $5 million exemption so no tax would apply.

Tax on $250,000 (per table): $70,800
Tax Credit of: US assets / Worldwide assets x Unified Tax Credit (which is the amount needed to exempt $1 million in assets i.e. the $345,800 tax on $1 million in assets in the table)
250,000/2,000,000 x 345,800 = $43,225
US Estate Tax Owed = US$27,575 or 11% of US assets
Should the 2001 rules become operative again, the Small Estate Exemption in the Canada - US Tax Treaty sets an exemption limit of US$1.2 million, up to which only US real property and business interests (which excludes stocks, bonds and intangible securities) are subject to estate tax, so that would help the Canadian investor.

No Double Taxation, Just Maximum Taxation
Canadians must of course, pay income tax on their worldwide assets, including US assets, so that introduces the possibility of double taxation. Though the Canadian taxpayer can claim the US estate taxes paid as a credit against Canadian taxes owing, thus eliminating double taxation, he/she often ends paying in total the US amount because the US estate taxes typically exceed Canadian capital gains tax as PriceWaterhouseCoopers explain in Estate Tax Update.

What to do
  • Die in 2010 (just kidding!) - No US estate taxes to pay at all but it is a bit too extreme a tax reduction measure!
  • Reduce US assets or Don't buy them in the first place - The less are the US assets, the lower the rate and the less tax to pay due to the sliding scale e.g. the same total estate with only $100k in US-situ assets would mean $6,510 owing, a 6.5% cost to US assets. There is an obvious trade-off to such an approach from an investment viewpoint since US markets offer the Canadian investor many opportunities for diversification, more companies in more sectors and many funds at cheaper fees than are available in Canada.
  • Buy Canadian mutual funds or ETFs that buy US holdings - This is a viable option since such funds are not considered as situated in the USA and thus not subject to the tax (see Richardson GMP's US Estate Taxes Overview).
  • Give away US investments before death - This works for investments since intangible property is exempt from another US law pertaining to gifts that catches and taxes other types of US assets.
  • Establish a Canadian corporation to hold investments, Consider joint vs tenants in common ownership between spouses - These might or might not help and you would need professional guidance to figure it out and do it properly.
  • Avoid the US tax by not reporting - definitely not advisable! If you invest in the USA, it is only fair to obey its laws, besides which the Canada - US Tax Treaty says the governments will exchange information to enforce taxes (see Article XXVII).
  • Seriously consider hiring tax and legal professionals - This whole subject is fraught with complexity and critical details that can be very costly. If you are above the threshold, whatever it becomes in 2011 and beyond after the political tussle in the US is over, seeking qualified professional advice could save you a lot of money. Though we have focused on investing issues, people with other types of property like vacation homes, or who are resident in the US, may have multiple factors to trade off and an integrated financial and tax plan devised with expert help becomes more and more advisable.
As this is written, the outcome of the tax legislation struggle in Washington is not known. However, we can confidently trot out the hoary expression enunciated thus by famous American Benjamin Franklin - "In this world nothing can be said to be certain, except death and taxes" (as found on The Phrase Finder), to which we will append for this blog post, the word "together".

Further Reading: For a more precise and complete description of the issue, read professional accountant firm BDO's US Estate Tax Issues for Canadians, and lawyer Joseph Grasmick's Canadian Snowbirds and US Tax.

Update December 22. The tax deal has become law.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 7 December 2010

Split Share Preferreds - Opportunity from an Outlier?

Preferred shares issued by Split Share Closed-End Funds (see Wikipedia article for a quick primer) offer another option to the investor who seeks reliable, regular income in the form of quarterly dividends. Usually that will be within a taxable account where the tax advantage of dividends can be put to use.

Apart from the steady income, there are several other beneficial features of such preferreds:
  • a fixed maturity date for a defined value, which has become quite uncommon amongst other types of preferred shares, and fixed dividend payments - you know how much money you get and when you get it, much like a GIC
  • most often five years or less to maturity - this reduces risk from rising interest rates (since the dividend for such preferreds is fixed the market price of the preferred share will fall as it does with bonds when interest rates go up)
  • cashable (called retraction) by the investor, though at a discount, directly from the split share corporation, which gives an alternative to selling back in the stock market
  • yield is often higher than ordinary retractable preferreds
  • as with all preferreds, priority of dividends over common shares - the preferreds get paid first and if not paid, get cumulated for future payment, unlike dividends on common shares
Of course, there are risks and potential pitfalls too:
  • call risk that the issuer will decide to buy back your shares (called redemption) before the maturity date, which could wipe out your profit if you paid far over the redemption maturity price when buying on the market
  • illiquidity i.e. shares hard to sell at all, or large bid vs ask price differentials, i.e. at a much lower price, when the shares are not very actively traded, as does happen with many split share preferreds
  • interest rate risk, or the decline in capital value when interest rate rise, as happens to all fixed income securities. There is a floor set by the redemption value.
  • credit risk, aka the risk of not getting paid dividends or losing your capital, which exists for any investment. This is a factor to examine when buying and it arises from the characteristics of the underlying operating companies whose shares the split share corporations hold. That is why the safest split shares hold a lot of stable Canadian banks, insurance companies, utilities and oil companies. Credit ratings from DBRS help a lot for assessing credit risk since there is wide variation amongst split share preferreds. DBRS rates each split preferred share. The DBRS rating Pfd-1 is the highest / most secure and Pfd-2 is also considered Investment Grade. Our comparison below looks only at shares rated Pfd-1 and -2, which gives us eleven split share corporations out of the 54 in total traded on the TSX.
The Investment Grade Preferred Split Shares
Two categories of split share funds exist. The first invests in a basket of shares from multiple companies and provides better diversification than the other type, which invests in the shares of a single company. It is no surprise that there are more multi-company investment grade preferreds. Here below is the current list:

Portfolio Redemption / Maturity Date Redemption Price
Multiple Underlying Companies

Allbanc Split Corp. ABK.PR.B Banks 10 Mar 2013 $26.75
Brompton Equity Split Corp. BE.PR.A similar to TSX 60 31 May 2011 $10.00
Big 8 Split Corp Class B 7.0% BIG.PR.B Banks & insurance companies 15 Dec 2013 $12.00
Big Bank Big Oil Split Corp. BBO.PR.A Banks, oil & gas companies 30 Dec 2016 $10.00
First Asset CanBanc Split Corp. CBU.PR.A Banks 15 Jan 2016 $10.00
CANADIAN Financials & Utilities Split Corp. CFS.PR.A Banks, utilities, pipelines, financial companies 31 Jan 2012 $10.00
Newgrowth Corp. Ser 2 6.0% NEW.PR.C Banks & utilities 26 Jun 2014 $13.70
Sixty Split Corp. SXT.PR.A TSX 60 15 Mar 2011 $25.00

Single Underlying Company

BNS Split Corp. II BSC.PR.B Bank of Nova Scotia common 22 Sep 2015 $18.85
BAM Split Corp. 4.95% Class AA Series I BNA.PR.B Brookfield Asset Management common 25 Mar 2016 $25.00
BAM Split Corp. 4.35% Class AA Series III BNA.PR.C Brookfield Asset Management common 10 Jan 2019 $25.00
BAM Split Corp. 7.25% Class AA Series IV BNA.PR.D Brookfield Asset Management common 9 Jul 2014 $26.00
TD Split Inc. TDS.PR.C TD Bank common 15 Nov 2015 $10.00

Comparison Measures of Value and Risk
The next table below shows the data for the selected preferreds in terms of:
1) Value - The current dividend yield (dividend over market price) does not tell an adequate story since the change in price between what is paid today for a preferred share and what you get back at maturity must be taken into account. The Yield to Maturity tells a more complete story, factoring in both the dividend and the eventual capital gain or loss if the preferred share is held to maturity. Unfortunately this critical figure is not apparently publicly available online and one must do the calculation oneself. Try Shakespeare's free downloadable spreadsheet (and read James Hymas' instructions here) which has the formulas into which you plug the details for a particular share issue. An additional calculation that can help assess a worst case on the downside (but which we have not done here) with the same spreadsheet is the yield to the earliest possible call date.

CBU.PR.A, CFS.PR.A and BE.PR.A look bad with their minimal or even negative yield to maturity. BBO.PR.A has the best yield amongst the broadly diversified preferreds, while BNA.PR.C and BNA.PR.D have even higher yields.

2) Call/ Early Redemption Factors - The likelihood that the split share fund company will exercise its option to redeem your shares before the maturity date and the possible harm that will cause you depends on several factors. First, if the current market price you pay is much higher than the redemption price, you stand to have a big capital loss, as would be the case most especially now for CBU.PR.A where the last market price is $13.69 while the redemption price is only $10. On the other hand, a BNA.PR.C shareholder would gain 10% over the market price (until January 10, 2012 the redemption price is actually $26, not the $25 maturity price shown in the table, which would be an even better gain).

Second, if the current market price of the capital shares of the split fund are trading far below the Net Asset Value (NAV), there is an incentive for those capital shareholders to turn their shares in for retraction, which then forces the split fund to call and redeem an equal number of preferred shares. (To find current NAV Premiums/Discounts, search for Closed-End Funds on GlobeInvestor). On that measure CBU.PR.A is also at high risk due to the big discount to NAV of 18.9% and CFS.PR.A is not far behind, while NEW.PR.C is at some risk.

3) Liquidity Factors - The more active the trading volume and the tighter the bid-ask spread of market price, the better off is the investor. Based on current data it is hard to make definitive judgements about our crop of preferreds though the three BAM split shares with their higher trading volumes and larger number of shares outstanding look a bit better than the rest.

The Pick of the Crop
Our analysis points to BNA.PR.C and BNA.PR.D as very attractive choices and BBO.PR.A as a solid choice amongst the split preferreds. Preferred share specialist James Hymas of Prefblog seems to share the favourable opinion of BNA.PR.C according to this recent post. The upward momentum of the underlying company Brookfield Asset Management in its latest quarterly report, and the further assurance that provides, strengthens the belief that the two BNA preferreds are a solid choice. There are also many other preferred shares (see this list on on the market. Perhaps there really is a very good deal available for the moment with the two BNA issues but, as ever, the online DIY investor must decide for him or herself whether to buy in.

Disclosure: The blog writer owns shares of BNA.PR.C.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.