Recently, a client asked us whether we should consider preferred shares as part of a portfolio's fixed income asset class. Before answering that question, it's essential to understand the characteristics of preferred shares and how they compare to traditional fixed income securities like bonds.

Preferred shares, like stocks, represent ownership in a company but have characteristics more similar to bonds than stocks. They often pay a fixed dividend that must be paid out before dividends can be distributed to common shareholders. Because this dividend is fixed, it gives preferred shares similar characteristics to bonds' fixed interest payments.

However, preferred shares also have some characteristics that differ from traditional fixed income securities: First, preferred shares have no maturity date and do not have a guaranteed return of capital upon maturity. Second, in the event of bankruptcy, preferred shareholders have a higher claim on assets than common shareholders, but are subordinate to bondholders. This means bondholders will be paid out before preferred shareholders in case of bankruptcy. Third, while preferred shares may have fixed dividend rates, their prices, like bonds, can still fluctuate based on changes in interest rates and other market factors. Fortunately, their sensitivity to interest rate changes may not be as high as that of bonds due to the above mentioned equity-like features.

Given these characteristics, we typically categorize preferred shares as more of a hybrid security because they combine equity and fixed income elements. While they provide regular fixed income-like dividends, they also carry risks associated with equities, such as price volatility and subordination in bankruptcy.

Whether preferred shares should be included in your portfolio depends on your investment strategy and risk tolerance. In Canada, liquidity for this asset class is lower than in the United States. However, purchasing Canadian preferred shares outside of a TFSA or registered account will give you the benefit of the dividend tax credit.

If preferred shares seem like an investment class you want to explore, the Allan Bush Investment Team would be happy to discuss the merits of specific securities to determine if they are appropriate for your overall portfolio and tolerance for risk.