ChrisNix wrote:stockton wrote:The question is surely "Why would an investor ever buy such prefs. at issue ?"
Very few investors were investing for
capital gain. As one observer put it, fixed interest instruments were the defenders and equites the strikers.
It's worth revisiting something a bit curious about the way preference shares are being viewed. The usual ranking of investment risk is that:
-money and equivalents are the most riskless assets: hence "a bird in hand is worth two in the bush", "cold hard cash", "cash is king" etc.;
-then less secure is dated government securities where cash will be repaid with a high degree of certainty on a set date with certain interest payments;
-then we have dated corporate debt where again cash flows are fairly certain, but with appreciable credit risk and higher coupons in compensation;
-even more risky are securities where no date is set for return of principal: bonds give a sure income stream but
-preference shares and ordinary shares cannot even offer security of income: their dividends are absolutely discretionary and principal does NOT have to be repaid.
So traditionally, and even now for savvy investors, preference shares are down there with junk:
it is a critical disadvantage not to know when your principal will be repaid in cash.
So the simple answer to stockton's question is that prefs had higher dividend rates than deposit interest, higher dividend rates than dated government debt, higher dividend rates than dated corporate debt and higher dividend rates than undated corporate debt. No mystery: they earned a higher return to compensate for their greater risk.
One cannot overemphasise how the psychology shown in this discussion is the reverse of the above and, frankly perverse [pref shares are "a safe, secure income"!!!] . Investors are approaching the preference share question as if it is an
advantage not to have the right to be repaid principal. This is utterly misguided and just a fashion, a product of elevated asset prices and low yields generally.
If one truly wants to understand what Chris Nix and others are saying then one needs to return to the orthodox mindset where cash is safe and undated equity is junk. Surely it doesn't need to be spelled out why this is the case and what the risks are. Aviva exposed merely one risk (loss of capital through overpaying at purchase), but it is not remotely the only risk to investors of these junky assets.
Gilt yields below 1% may be the lipstick on the preference share pig, but to mix metaphors: wake up and smell the piggy before it's too late.
GS