Pref shares - Big bad wolf or red riding hood?

It depends on the view - short term or long term.

There are currently 39 pref shares listed on the JSE, with a total market cap of R26bn. Financials hold the lion's share at 83% of the listed instruments, and they generally pay a dividend linked to the prime rate.

Its about timing your entrance and exit points says Paul Crawford from RMB Asset Management, but its not a panacea. It must be treated like any investment, you buy it to make money. He maintains that this is a short-term investment and even better as a shorting instrument. There is no long term game here.

Preference shares, according to Crawford, speaking at the Momentum investment conference in the North West province, are not always what they appear to be, specifically with all thats going on in the listed prefs sector.

And, according to Crawford - who by his own admission is Scottish and an engineer, and who always looks for efficiency - his warning lights have been going on because of the proliferation of instruments listed.
 
Crawford got anxious when more and more of these instruments began appearing, because if the collective wisdom was to be believed then prefs are almost a one-way bet. This is not the case.

He maintains that it's a zero sum game, however. The marketing speak is confusing and he says that there will be defaulters over the fullness of time, and there is risk, in terms of capital and interest rate. The argument in the marketing speak is that the SARB will bail out the banks is not accurate. The SARB will bail out the man on the street, not the big banks or the informed professional investors.

Crawford says that no one guarantees liquidity on prefs - and as such the investor takes market risk, so beware and understand the risk. Essentially these are shares and nothing more.

It's about liquidity and when analyzing the liquidity on a daily basis, there is on average R100 000 in value traded every day. This is all fine and well if you hold less than R100 000. If you are an institutional investor with an exposure of a couple of million or billion rands, you have a problem.

Equity out-performs pref shares
He did a comparison between a pref dividend and an equity dividend in the same investment sector over a ten-year period. The pref will out-perform at the beginning and then under-perform against the equity in the same sector.

The capital performance is a different picture. You may have the capital, but the share price has compounded and significantly out-performed the pref share capital.

Prefs vs listed property
Prefs did out-perform in certain periods, although there was less volatility in the listed property sector, but again the listed property sector out-performed long term.

Editor's thoughts:
* This investment class is a technical minefield and any thoughts of entering it must be discussed with experts, as is the case with any asset class.