What you need to know about preference shares

What you need to know about preference shares

By A Tan

In a previous article on the top 3 investments to help beat Singapore inflation some readers brought up another noteworthy way to avoid a negative real interest rate — preference shares. This article explores what preference shares are, the sort of returns you can get from them, how to invest in them and what you should be aware of before investing.

What are preference shares?

Preference shares are a special type of equity security that has properties of both shares and fixed income securities. Issued by companies, preferred shares provide a return in the form of fixed periodic payments. Unlike regular shares, however, you usually do not get voting rights. Instead, you are promised, but not guaranteed a dividend for your preference shares.

The difference with bonds is that the interest payment on a bond must be paid (unless the company goes into default) to the bondholder. For preference shares, the company can choose to withhold the dividend as long as they do not pay ordinary shareholders a dividend. Thus preference shares have priority over ordinary shares in terms of dividend payment and liquidation, but are junior to bonds.

What are the benefits of investing in preference shares?

An investor in preference shares can earn a return on the investment from the interest payment, and also has the potential for capital appreciation upon sale of the shares in the market, although this tends to be limited relative to ordinary shares.

Preference shares provide you with a predictable income stream, where you know how much interest you can expect to receive and how often you will receive it. However, note that the dividend on preference shares is not guaranteed.

Preference shares also have the advantage of transparency. Unlike bonds that are traded over the counter, investors can easily access real-time price and volume information via the SGX website or on their brokers' trading platforms.

What sort of returns can you get from preference shares?

The dividend of a preference share is usually fixed at the time of issue, and your yield will depend on the price you bought it at. For example, if you bought a 5 percent per annum dividend yield preference share at the par value of $100 per share, then your yield is 5 percent. If you bought it at $110 per share instead, then your yield is $5/$110 or 4.55 percent.

In terms of capital gains or losses, the price of a preference share is mainly affected by interest rates and credit risk. If the credit rating of a preference share issuer drops, the price of the share should drop. Like bonds, the price of preference shares has an inverse relationship with interest rates. If interest rates fall, the price of a preference share should go up.

How do you invest in preference shares?

Preference shares are traded on the Singapore Exchange. The process of buying and selling a preference share is similar to that of a buying an ordinary share. Your trade can be executed through a broker or online platform during trading hours, and can be bought and sold using stop-loss orders, limit orders and margin purchases, just like shares.

What are the risks of investing in preference shares?

You are exposed to market risk and preference shares can vary in price, depending on the forces of supply and demand and interest rate changes. You are also exposed to credit risk — the risk that the issuer may not have the cash to meet its dividend payments.

Preference shares tend to be less liquid than ordinary shares, so you may not be able to buy or sell your shares in the quantity or at the price that you want to do so.

Also, your preference shares may be redeemed by the issuer. The issuer often has the right but not the obligation to redeem these shares after a certain period of time, but shareholders have no right to call for their redemption.

Which companies are issuing preference shares?

Current preference shares issuers include DBS Group, OCBC Corporation, UOB, City Developments Limited and United Engineers. The full list of preference shares is available at the SGX website.

Also on April 13 2011, Singapore water treatment firm Hyflux announced that it would sell up to S$200 million of Class A preference shares at a dividend rate of 6 percent per annum.

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