Q — With interest rates starting to rise, is this an opportunity to consider floating rate preferreds? — Gunnar A.
A — In theory, floating rate preferreds should perform well during a period of rising rates. That's because their dividend is tied to a benchmark rate, such as prime or the yield on a government bond. When rates rise, the dividend should move higher accordingly, although there will be a delay depending on the terms of the issue. So far, of the floating rate preferreds I checked, most are showing little or no strong upward movement.
One preferred that is trending a little higher is TransCanada's Cumulative Redeemable First Preferred Shares, Series 2 (TSX: TRP.PR.F). These shares began trading at the end of 2014 following a conversion from a previous series. They have been battered for much of the time since, hitting a low of $10.19 last February. However, they bounced back in the fall as the interest rates began to rise and are up about 45% from last winter's low.
In this case, the dividend is set each quarter at the rate of a five-year Canada bond plus 1.92 per cent. This means that as the bond yield rises, so will the dividend that investors receive. The latest quarterly payment in November was $0.1528 per share. Over a year that would work out to a yield of 4.1%. However, with rates on the rise, the dividend should increase in 2017.
Overall, floating rate preferreds should rise in price as interest rates go up, but they won't always move in lock step. Depending on the terms of the preferred there can be a delay of as much as a year between the time rates rise and the stock dividend moves higher. — G.P.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.
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