Glen Copans, Chief Investment Officer at Investec Specialist Investments (ISI), explains some of the investment instruments and vehicles available, the key risks involved and their performance since the market crash in March.
The different types of preference share available
Perpetual preference shares are more like equities, however. They tend to exhibit similar volatility to that of the equity market overall, while their poor liquidity also contributes to higher volatility, especially during the spike in global volatility in March. While perpetual preference shares have delivered marginally positive returns over time, they have not beaten inflation.
Watch the video
00.14 – How have preference shares performed in the last few months?
02.08 – What are the underlying risks that an investor needs to be aware of?
07.04 – With dividends being cancelled or postponed, what impact does this have on investors’ ability to earn dividend income?
10.28 – How are dividend income funds performing in the light interest rates having fallen so dramatically?
12.49 – In a world of low interest rates and yields, what is the outlook for the dividend income funds? Is this still a viable investment choice?
On the underlying risks for preference share investors
When it comes to credit risk, Copans notes that this refers to the debt obligations of the underlying businesses of the issuers and the likelihood of default. Copans says there have been big dislocations in performance since March, based on the underlying creditworthiness of issuers, with some issuers doing better than others.
“Banks, the main issuers, are well-capitalised, liquid and well-regulated, so pose less of a credit risk, but this is different as you move to other issuers, so you need to be more selective,” he says.
Many preference shares are not heavily traded, so investors need to take into account the liquidity risk when looking at potentially selling out of a position or taking a position. “To manage the liquidity risk, investors should stick to the basic principles of diversification strategies. This means that lack of liquidity can be managed,” explains Copans.
Investors should keep an eye on changes in the law or regulation that might have an impact on the tax treatment of specific asset classes. “While we haven’t seen any changes of late, tax risk is something investors should be aware of,” he notes.
Banks, the main issuers, are well-capitalised, liquid and well-regulated, so pose less of a credit risk, but this is different as you move to other issuers, so you need to be more selective
Glen Copans, Chief Investment Officer at Investec Specialist Investments
On the impact of companies cancelling, deferring or reducing their dividends
Furthermore, the Reserve Bank earlier this year issued a directive to banks to prudently manage their balance sheets, which has led them to defer dividends in order to preserve capital.
This raises the question of dividend risk in the context of preference shares. Copans explains: “A company’s preference shares form a different component of its capital structure from its ordinary shares, so we don’t believe preference shares will be impacted for now. So far, it’s the equity holders that have been affected.”
In order to manage for sectors that have stopped or reduced dividends, such as retail, investors may look to substitute sectors, such as by investing in commodity or technology companies, but should be more selective. As always, investors should remember to remain well-diversified. “You shouldn’t put all of your money into one investment thesis so that you can account for all of these risks,” says Copans.
Income funds and dividend income funds
Dividend income funds are an alternative to money market and income funds, offering high levels of liquidity alongside consistent, predictable returns – something that has largely held up in the current market. Investors have seen absolute levels fall, but this has been largely linked to lower interest rates.
Outlook for dividend income funds
“Again, the important thing is to have the right portfolio construction in place,” says Copans. “You need exposure to different asset classes, to ensure you are well diversified.” Copans explains that, in times of high volatility, as we have seen in recent months, there is a tendency for investors to retreat from the market and hold higher levels of cash than they otherwise would.
However finding the right opportunity to re-enter the market is difficult and, as a result, investors end up holding cash (at low) rates for longer, and their returns are eroded. “Holdings in cash that were intended to be held for a short period, end up being held for much longer.”
In these scenarios, it might be worthwhile to look at other alternative assets. “Any investment where you get an enhanced return relative to after-tax money market rates, without the commensurate level of risk being taken, is a strategy worth looking at,” Copans points out. “Remember too, that as rates move up, so these investments should too.”