Tan Kin Lian's Blog: Preference shares

Saturday, July 24, 2010

Preference shares

Dear Mr Tan,
I used to buy Singapore Government Bonds, when yields were at 2 to 3%. Now it is not worth my trouble.

I am aware of preference shares that are issued by DBS, UOB and OCBC. For OCBC, their coupons are 3.93%, 4.2%, 4.5% and 5.1%. This is what I am most familiar with. I bought a small amount for my mum's retirement fund.

In summary, they are perpetual and non-cumulative. Of course the other risks associated with debt securities apply.
They are rather illiquid. Looking at the OCBC annual report, one can see that they are held in rather large quantities by institutions.

I read in Benjamin Graham's The Intelligent Investor that the best time to buy them is during market turmoil when prices are depressed. That is when the yields are sufficiently high to compensate for the potential risks.

NL

3 comments:

Createwealth8888 said...: Buying during market crashes. It is easier said than done. Most retail investors will find it very difficult to execute it.

Investing in stock market is more than just stock analysis and stock picking.

Personal money and risk management will play a bigger role in determining your investing success and the net returns on your investing capital.; July 25, 2010 9:01 AM
hyom said...: (Someone wrote: I read in Benjamin Graham's The Intelligent Investor that the best time to buy them is during market turmoil when prices are depressed. )

Yes, I remembered that Benjamin Graham did mention that preference shares are to be bought on a depressed basis. Preference shares have certain characteristics that makes it even more necessary to buy them on a depressed price than common shares.

When bought at or above par value (SGD100 in Singapore's context), preference shares do not take part in the profitable growth of the company. The company can announce 50%-100% profit growth, but the price of the preference shares will move up only a little. If you bought the common shares, it is possible to earn capital appreciation of 100% and above with this kind of performance. To appreciate this point, compare the price charts of UOB shares and UOB 5.05% NCPS from Mar 2008 onwards.

However, if you bought on a depressed price well below par value, the preference shares do participate in the growth of the company until the price reaches par value (but rise slowly after this point). When you buy preference shares on a depressed price, you enjoy both capital appreciation and higher dividend yield if the company recovers.

The best reason for not buying preference shares at non-depressed levels is that they decline more in adversity but do not rise much in prosperity. Again, look at the price chart of the preference shares to appreciate this point. In investing, if the downside exceeds the upside, you don't invest. Also, when the banks redeem the preference shares, they will redeem it at par. So, if you bought the preference shares above par, you suffer a loss in principal upon redemption.

Now that most preference shares are trading above par, I personally will not buy them. Unfortunately, I was not smart enough to buy them in 2008 and early 2009 on a depressed basis. So much for talk only.

Correct me if the above write-up contains misinformation. I am an engineer with no financial background but like to read a lot before putting my money at risk.; July 25, 2010 10:56 AM
Unknown said...: Hi, just want to add that.....
preference shares are like quasi perpetual bonds. With interest rate being abnormally low for so long, the only logical, natural direction is for them to go up !!
When that would happen, who know ? But you can be sure, when that happens preference shares are going to tumble !; August 01, 2010 9:18 AM