Oran Hall | Preference shares becoming attractive sources of income
Preference shares still do not hold a preferred position as investment instruments in the Jamaican securities market, but a look at issues in the last decade shows that much is being done to make them appealing to the market.
Whereas they were primarily fixed-rate long term instruments in the past, they are now better described as medium-term instruments due to their shorter term to maturity - often less than 10 years. Beyond that, several new features have been incorporated into the more recent issues.
Newer issues have been made as Jamaican-dollar securities but some have been US-dollar securities although they have generally been directed only to investors who are resident in Jamaica. Even so, Jamaican investors are protected against the decline in the value of the Jamaican currency if they invest in preference shares denominated in the US dollar.
Some recent issues have been fixed-rate issues but there have been variable rate issues as well, thereby offering greater protection to the value of the shares in the secondary market, which may be affected by medium to long term interest rate changes.
The frequency of dividend payments has also changed. At an earlier time, dividends tended to be paid twice yearly. Today, they are paid quarterly. More than that, some issues pay interest monthly. This is a godsend for investors who need a regular and known stream of income at reasonable rates.
One issuer has found it worthwhile to offer a higher rate to its own clients than to other investors - a kind of reward, no doubt, for supporting the business of the issuer.
For those listed on the Jamaica Stock Exchange Main Market and Junior Market, there is some liquidity although trading in preference shares is not yet vibrant locally.
Investors may still invest as individuals but may also do so jointly, thereby addressing estate-planning issues up front.
Although this has no effect on the trading of these securities, issues are not only confined to shares with a face value as some no par value shares have been issued in recent times.
The redeemable and cumulative features add to their attractiveness. Being redeemable means that they have a limited life span which is known; the investor has reasonable reason for expecting a return of principal at maturity/redemption. The cumulative feature protects the income of the investor who is thus comforted that interest not paid now will accumulate to be paid in the future.
Preference shareholders have a prior claim to dividends over ordinary shareholders and to principal in the event of liquidation although they rank behind holders of the issuer's debt instruments.
Additionally, they tend not to have voting rights - that being reserved for special situations which are pre-determined such as the non-payment of preference dividends for a specified period such as one year.
The current approach to preference shares in the market is ensuring that there is scope to satisfy a wide range of investment objectives. Although the scope for capital appreciation is limited, there is great scope for a regular flow of income, on the other hand.
The regular payment of dividends and limited downside risk with regard to the price of the securities make the preference shares now on market a strong alternative to debt instruments.
HIGH NET WORTH
The low price at which the new shares come to the market also makes them quite attractive to investors: institutional investors, high net worth individuals and particularly individuals aspiring to be high net worth persons one day.
Current investors are protected by, for example, a requirement that any change in the terms of an issue has to be approved by a set substantial percentage of the preference shareholders. From another angle, to the extent that interest rates do not rise significantly, investors can expect that the capital value of their investment will be protected as the price of the shares tends not to fall much in such cases.
To their issuers, preference shares are useful sources of funding as they have been used to raise capital in the local market to re-finance existing debt, to support diversification and expansion and to fund the expansion of credit facilities to the clients of the issuers.
I find it interesting that it is the financial institutions which seem to be more inclined to use the preference share facility as an option for raising capital thereby giving investors another option for earning interest income.
- Oran A. Hall, principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel. Email firstname.lastname@example.org