This article was published on 17 October 2009. Some information may be out of date.

Q&As

  • Are preference shares a good investment, despite recent price falls?
  • Did reader get good advice from an ASB adviser?

QI have always considered preference shares had two attributes compared to ordinary shares in that they have more assured dividends and should be less volatile.

ASB, Origin Energy and Rabo Bank have all issued preference shares in the last two years that have dividend annual reset rates based on one-year swap rates. This I recognised would limit the prospect of capital gain, but I assumed that the capital value of the shares would stay close to par. Not so. The capital values presently are: ASB, 72 per cent, Origin Energy, 63 per cent and Rabo, 82 per cent of par value.

Can you advise what the market conditions would be, whereby I could expect their values to move closer to par?

The obvious answer is “when swap rates rise”. However I have a nasty feeling that general rates will also rise and the capital value of these preference shares is likely to remain heavily discounted. Is there hope or have I been conned?

AThere’s hope, but don’t hold your breath. As to whether you’ve been conned, that depends on what you were told when you bought the preference shares.

To put others in the picture, preference shares generally fall between bonds and ordinary shares in risk and volatility, so the returns should also be in between. They are usually perpetual — meaning they have no maturity date. To get your money back, you need to sell the shares.

If the company gets into trouble, preference shareholders stand in line after bondholders but before ordinary shareholders.

Traditionally, preference shares paid a fixed dividend. But recently issuers have tended to regularly reset the dividend rates, as you describe.

“A few years ago, some companies issued them when there was a shortage of bonds, and so the margin they offered was low given the risk,” says Michael Chamberlain of SuperLife.

Since then, interest rates have risen, so the value of the preference shares has fallen, pushing up their future expected returns to reflect their risk. “For them to move back to par, the markets would again have to be tight,” says Chamberlain.

He concludes that you probably paid too much for the preference shares. If he’s correct, it will take another shortage of better alternatives for their value to rise to par — their original issue price. It could be a long wait.

Even if the preference shares had been priced better, Chamberlain doesn’t like them. “No investor should buy perpetual bonds or preference shares. The only way to get your money back is to sell them,” and therefore pay transaction costs. You also run the risk the market price will be below par, as it is now. By comparison, if you hold ordinary bonds you get your money back at maturity and pay no brokerage.

QWhen I retired in 2003, I went to the ASB for advice as to what to do with $250,000 proceeds from selling a business. An ASB investment adviser, who was a salaried employee who received incentives according to sales made, recommended ASB preference shares, and that is where I put it.

At the time we had no debts and owned our home and a bach. We had other investments, in shares, finance companies, property funds and bank deposits totaling $328,000, plus the ASB perpetual preference shares of $250,000.

Some time after that we changed houses and sold our preference shares.

We went back to ASB in late 2007 and asked if the preference shares were still a good idea, and on the adviser’s advice repurchased $73,150 in ASB Capital Ltd. and $100,000 in ASB Capital No 2. At that time our other investments were $400,000 in bank term deposits.

The income returns on the preference shares have always been good, as I expected.

However, the shares cost $1 each, but over the past few years have reduced in value to 60 to 80 cents. We did not realise that the ASB Shares could fall in value the same as any other shares. So our $173,150 at $1 per share is now worth about $121,205.

As I understand it, if I don’t sell, the return should continue as if there was no change in value. However, if I need the money then I lose 20 to 40 per cent of my fund.

Was this a good investment? Like many people one imagines that cash in the bank is sacred but this example could show otherwise.

AASB stands by its adviser’s choice for you. “Highly rated preference shares are usually a good part of an overall portfolio,” says a spokesperson. “For a retired person looking for a regular income they can be a good option.

“However, the investor must be aware that the level of dividends will fluctuate, plus there is risk associated with their capital if they want to redeem their shares. The investment statement and prospectus clearly explains the risks associated with a preference share issue.”

Michael Chamberlain of SuperLife is not impressed. “Preference shares cannot be a good part of a retiree’s overall portfolio because the retiree will die before they mature, and also they can’t spend the capital unless they sell.” He adds, “No investment statement or prospectus clearly explains the risks. An adviser cannot expect a mum and dad investor to read and understand it.”

Chamberlain also notes that preference shares are not tax efficient for most retirees unless they are PIEs. The ASB preference shares were “PIE’d” in February this year, but that’s long after you made your investments.

There are other issues here too. The following are questions I put to ASB and their responses, plus some further points from me and our reader:

  • If you do think preference shares were suitable for this couple, on what basis should the adviser have chosen ASB preference shares over others?

    ASB: “The bank provides a list of approved investments that the investment adviser is authorised to recommend. He or she provides the investor with a range of investment options depending on their risk/return appetite. In 2003 the adviser offered the preference shares after providing full disclosure of his relationship with ASB and the relevant investment statement.”

    My comment: The reader seems to have chosen the ASB shares with his eyes open. Still, it’s hard to imagine an independent adviser would have recommended such heavy investment in ASB.

  • Wouldn’t the couple’s risk have been lower with a range of different preference shares?

    ASB: “It would depend on the time of purchase, the price paid and the quality and rating of the particular preference share.”

    This answer surprised me. Read on.

  • Even if you do think preference shares were suitable, should they have been told to put 43 per cent and later 30 per cent of their savings into the one type of investment?

    ASB: “The recommendation to each investor always depends on the customer’s full financial picture, plus their goals, timeframe and attitude to investment risk and reward. In this case an ASB investment adviser was not consulted for the second purchase of preference shares.”

    Our reader says he did consult the adviser the second time. “He advised me that the shares were still a very good investment and that I should purchase them through ASB Securities, which I did.”

    Regardless of whose story is correct, the main point is that it seems ASB doesn’t understand a basic investment rule: diversify.

  • Do you have any comment on the fact that the couple didn’t realise the value of the preference shares could fall?

    ASB: “Our records indicate that full disclosure was made, and in this case the customer was an experienced investor. Contrary to what has been disclosed to you, this particular investor did realise that the market value of the ASB Capital preference shares does fluctuate. His course of dealing in these preference shares confirms this. In 2004 when he sold these shares he made a gain. When he bought the preference shares again in 2007 … he bought them online through ASB Securities,” with one purchase costing a little over $1 a share and the other 98 cents.

    The reader’s response: “Yes I was aware that most shares fluctuate in value. However, I viewed the ASB preference shares as being quite different. ASB has always been a very profitable operation, and it was explained to me right from the start that the purpose of the shares was for ASB to invest within the ASB group of companies — and it would not be affected as it may be by investing outside of ASB.

    “Never would one have expected that the value of the shares would reduce by 30 per cent.”

  • How much did the adviser receive in commissions or performance-based pay for the original $250,000 investment and for the subsequent $173,150 re-investment, and was that disclosed to the couple?

    ASB: “Back in 2003, advisers were paid up to 25 basis points on the dollar amount invested in ASB preference shares. The second purchase was via the ASB Securities online channel and as an adviser was not involved, no adviser commission was received at all.”

    That amounts to $625 on the $250,000 — a nice bonus. ASB didn’t say whether it was disclosed.

The reader added, in a general response to ASB’s answers, “I accept that the ASB would put the onus on the investor to understand the risks of investment, and as I have said to you I am not crying poor because I was not well advised.

“I simply find it very strange that shares in such a group as ASB could drop so far in value. Had the $250,000 been all we had it would have been quite painful. However, we have been fortunate in that with the variety of investments we are enjoying our retirement. I could weep when I read of the Blue Chip investors who have been left with less than nothing.

“It may be that the value of the ASB shares will rise in due course, and we will make sure they are the last we sell.”

A gracious man. But I’m left feeling uncomfortable, particularly about the lack of diversification. Either the adviser doesn’t understand its importance or he chose to ignore it. I wonder how the banking ombudsman would judge the quality of his advice.

This is a good example of quite a common problem. Even when advisers tell clients that their advice might be biased towards certain products — and therefore probably not in the clients’ best interests — clients take the advice.

People need to be more aware of how an adviser’s lack of independence can affect them. Here’s hoping the coming changes to the financial adviser rules will lead to more awareness.

The story also highlights the need for advisers to discuss worst case scenarios with their clients — and for clients to push for that information.

By the way, in case anyone is wondering, ASB discussed the reader’s situation with me only after the reader gave permission for the bank to do so.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.