The BOC raised its overnight lending rate to 1.50% from 1.25% on July 11th. The move had little initial impact on bond yields, in part because it had been widely anticipated, but also because the BOC was not expected to raise interest rates again before early next year. However, an unexpected jump in the inflation rate to a six year high of 2.5% later in the month led many market participants to anticipate the BOC raising rates again this October, and bond yields moved higher in reaction. Preferred share prices moved higher on the BOC’s move and again as bond yields rose later in the month.
There were a number of preferred share issuers in the news during July. Enbridge Inc. announced the sale of $4.3 billion of its Canadian natural gas gathering and processing businesses, including its Westcoast transmission system in B.C. and Alliance Pipeline. The proposed transaction brings year-to-date sales of roughly $7.5 billion, above Enbridge’s previously announced 2018 target of $3 billion. The asset sales have been required in order to reduce Enbridge’s funding requirements for its very large capital spending plan. The news of the latest sale prompted a small rally in Enbridge preferred shares, but they still yield substantially more than other pipeline companies’ issues.
Another preferred share issuer, Aimia, was the subject of two hostile bids in July. Air Canada headed a consortium offering to buy Aeroplan and Grupo Aeromexico for the remaining share of the loyalty programme that Aimia runs for them. Aimia rejected both bids, but the potential for an asset sale prompted a sharp rally in the value of Aimia preferred shares. The dividends on the preferred shares were suspended last summer, but are cumulative, so a deal could result in them being brought current.
In addition, Emera announced that it would not be redeeming the 10,000,000 shares of EMA.PR.C. Holders of the issue had until July 31st to decide whether to take the new fixed rate of 4.721% (up from the original 4.10% rate) or opt for the floating rate option that initially would be 4.114%.
For the second consecutive month, there were no new preferred share issues. We anticipate that August will also be quiet because banks, which are significant issuers of preferred shares, will be in blackout mode until the release of their quarterly financial results late in the month.
Preferred share Exchange Traded Funds (ETFs) experienced the summer doldrums in July. The five largest funds had net inflows of only $55 million in the month. The two passive ETFs were net losers.
Natixis Canadian Preferred Share Fund
Some of the fund’s perpetual type holdings gave back a portion of their gains from a month earlier. As well, the relatively low trading volumes during July resulted in some random variability of returns.
Noteworthy transactions included the sale of the Enbridge U.S. dollar denominated shares following weakness in the Canadian exchange rate. We added to a number of existing holdings to invest net deposits and reduce cash levels. The cash level was 5.2% at month end, down from 7.7% at the end of June.
Market Outlook and Strategy
We are cautiously optimistic regarding preferred shares over the balance of 2018. Economically, Canada is in such good shape that the ever-cautious BOC is comfortable gradually removing its extraordinary monetary stimulus. The BOC’s statement following the July 11th rate increase indicated that it would be very data-dependent in determining the next rate increase. Since then, the data has included a surprising jump in the inflation rate and stronger than expected economic indicators which have caused the consensus to shift to anticipating the next rate hike to be as soon as October. If that occurs, the BOC will be in good company because the U.S. Federal Reserve is expected to raise its administered rates in both September and December.
Bond yields should follow the lead of the central banks’ rate moves and move upward. Higher bond yields should bode well for rate reset issue trading at discounts to par as investors anticipate rising dividend rates when the issues reset. Floating rate preferred issues should also benefit from the anticipated rate increases. New issue supply is expected to remain constrained, thereby supporting share prices.
From a longer-term perspective, most preferred shares continue to be attractive. Relative to bonds, the yields available on preferred shares are significantly higher, even before the more favourable tax treatment of dividends is considered. A number of perpetual preferred share issues, for example, have yields of 5.50% or better. In addition, if the consensus regarding bond yields trending up is correct, rate reset issues will continue to increase their dividend rates. The higher dividend rates, in turn, should be supportive of prices.
Our outlook for preferred shares assumes that the current trade tensions do not escalate into a full-blown global trade war that leads to a recession. While that is a non-trivial risk, we do not think it the most likely outcome. Rather, we believe that the U.S. will be able to renegotiate some aspects of its trading relationships without the current and threatened tariffs becoming permanent. However, we are monitoring developments closely and will make adjustments to the portfolio if they become appropriate.
For more information about Natixis Canadian Preferred Share Funds, please contact your financial advisor.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual fund securities are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer.
This release may contain “forward-looking statements” which reflect the current expectations of Natixis Investment Managers Canada LP and/or its sub-advisor, J. Zechner Associates Inc. (“J. Zechner”). These statements reflect the applicable management’s current beliefs with respect to future events and are based on information currently available to such management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements including, without limitation, those listed under the heading “Risk Factors” in the Natixis Investment Managers Canada LP Funds prospectus, which is available on Natixis Investment Managers Canada LP’s website and on SEDAR at www.sedar.com. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this release. Although the forward-looking statements contained in this release are based upon what Natixis Investment Managers Canada LP and/or J. Zechner believes to be reasonable assumptions, Natixis Investment Managers Canada LP and J. Zechner cannot assure investors that actual results, performance or achievements will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this release and Natixis Investment Managers Canada LP and J. Zechner do not assume any obligation to update or revise them to reflect new events or circumstances.
Natixis Investment Managers Canada LP is the manager of the Fund and is an affiliate of Natixis Investment Managers S.A.