Financial Adviser | Preference shares as investment option
QUESTION: I just came across an article you wrote for The Gleaner regarding where to invest large sums of money. I'd like to put aside approximately US$18,000, which is currently sitting in a regular account. I'm not a risk taker when it comes to money, but since it's not being used at the moment, I don't mind putting it elsewhere and earn a little more interest. Unfortunately, I'm not able to gather much from the websites of most investment banks and, therefore, unable to make comparisons. Would you mind giving a few suggestions on which accounts would be better options? My intention is to use the interest earned to offset expenses for my ailing parents. Thanks for your time and consideration.
FINANCIAL ADVISER: In my response to the above last week, I proposed Government of Jamaica global bonds as an option. Here is another option - preference shares. There is no US dollar-denominated preference share listed on the Jamaica Stock Exchange, but it is expected that two will be listed soon.
The shares expected to be listed are the Jamaica Money Market preference shares, which were successfully floated recently. They will be redeemed in 2024. Dividends are cumulative and payable quarterly. One, for non-clients of JMMB, pays interest at the rate of 5.75% and the other, for clients, at 6.00%. Should these shares be approved for listing, there is no guarantee they would be readily available.
Preference shares are company stock on which dividends, which are generally paid at a fixed rate or as a fixed sum, are paid to their owners before dividends are paid to owners of common stock, also called ordinary shares.
In the event of liquidation due to bankruptcy, preference shareholders are entitled to be paid from the liquidation of assets before ordinary shareholders. Preference shareholders are owners, along with common shareholders.
Although their claims rank above those of ordinary shareholders, they rank below the claims of creditors, such as bond and debenture holders. In the event of the winding up or liquidation of the issuing company, preference shareholders are entitled to funds up to a stated amount after creditors and debt holders have been paid in full.
Preference dividends are usually paid on a set schedule, generally quarterly or half-yearly, but a company may also decide not to pay preference dividends because of a decline of its profits.
But the situation is different for preference shares which have a cumulative feature; if dividends are not paid when due, they accumulate arrears which must be paid before dividends are paid on common stock or before the preference shares are redeemed.
Although preference shares do not generally have a maturity date, some do, and are called redeemable preference shares. These must be bought back by the issuer at an agreed date for an agreed price.
Because most preference shares are essentially fixed-income securities, they trade on a yield basis and do not offer the same potential for capital gains as common stocks do. Generally, their price tends to respond to interest rate movements, rising when interest rates fall and falling when interest rates rise.
Nonetheless, they are a reliable source of income and are generally quite safe investment instruments. Dividends are not taxed at source but are taxable.
Preference shares are similar to bonds in the sense that they generally pay fixed dividends as bonds generally pay interest at a fixed rate and their price on the secondary market moves in an opposite direction to the direction of interest rates, but, unlike bonds, they are not debt instruments.
With regard to trading, there is no accumulated interest to pay to the seller as in the case of bonds but there are some expenses, such as broker's commission, which tend to be about 2%, JSE cess at the rate of $3 per $1,000 and JCSD settlement fee, which is scaled; for example, it is $100 up to $50,000 and $400 for transactions with a value of more than $1 million and up to $5 million.
Bear in mind that although there is no commission on bonds, the intermediary institution does take a spread on the transaction by selling at a higher price to the buyer than the price it pays to the seller.
There is not a significant difference in the income from the bonds I mentioned last week and the income from the preference shares I mentioned today, and none has a tax advantage over the other. The term of the preference shares is equal to or less than that of the bonds I mentioned, but the preference shares could be better for your cash flow as they pay dividends four times per year in contrast to the two payments on the global bonds.
Oran A. Hall, principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel firstname.lastname@example.org