Honest Money
Honest Money
Understanding Preference Shares: Are They Still Worth It?
In today's episode, Warren Ingram answers your questions about preference shares, explaining how they work and why their popularity has waned among private investors. He discusses their volatility due to interest rate fluctuations and suggests RSA retail bonds as a more stable alternative. Warren also touches on stock exchange platforms like Altex, which has faced challenges, and A2X, which is geared more toward institutional investors.
Takeaways
- Preference shares are a form of investment where individuals lend money to a company in exchange for a fixed dividend payment.
- The price of preference shares is influenced by the interest rate environment, making them volatile.
- RSA retail bonds may be a better option for stability and certainty.
- Altex has struggled due to economic downturns and compliance issues.
- A2X is designed for institutional investors and not for private investors.
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Speaker 2:Hey Warren, thank you so much for Honest Money. I learn so much every time I listen. I've got two questions for you. The first one is can a retail investor own preference shares and is that a good idea to have as part of your portfolio? And the second question is why is no one talking about earning shares on AltX or A2X, and can a retail investor own shares there? Thanks so much.
Speaker 3:Thank you so much for your question about PrefShares. And then the tricky question, the real high-grade question, about AltX and A2X. So let's get to PreferenceShares first. I think just to explain what PreferenceShares are, so that we get to you know why would someone want to buy them. We get to you know why would someone want to buy them.
Speaker 3:So a preference share is? It's very similar to basically a company borrowing money from people but instead of, you know, offering them a guaranteed interest rate you know that's taxable what they do is they issue a preference share. So you buy preference shares, you give the company the money and the company then uses that money. In exchange, they would say to you that we promise to pay you whatever it is could be 75% of the prime interest rate as a dividend. So the reason it's called a preference share is because the company is forced to repay the preference share dividends before they pay dividends to any other ordinary shareholders. So preference share versus ordinary share. But the difference with a preference share is the price of the preference share starts on day one. Let's just say they issue it at a rand and the only thing that moves the preference share price is not the performance of the company, but rather the interest rate environment. You know where the interest rates are going up or down will then cause the price of the preference share to go up or down as well. I guess I mean, if you sketch a bad scenario, the price of the preference share could also collapse if the company is busy collapsing. So I guess there is a way where the performance of the company can impact the preference share price as well. So the logic of a company issuing a preference share is that they get a bit more access to money. They don't pay as high interest rates as they would pay to the banks, or if they were big enough to issue a bond, maybe they don't have to pay as high interest rates to bondholders. So it could be a bit of a cheaper form of debt for companies.
Speaker 3:Now preference shares used to be quite cheap sorry, not cheap popular because it was nice for private investors. We could all buy them. They were trading on the stock exchange and if you were looking for a relatively high tax-free interest rate because, remember, it's a dividend, so you're not paying tax on the dividend and you want certainty around your money then you say to yourself well, I think interest rates are stable, I'm going to take a 75% of prime pref share. Whatever the company's name is, you think it's a decent big company. They're not going to go bang. They've got a good balance sheet. Yes, I'm going to buy that pref share and then you hold the preference share. You earn your tax-free dividend Remember getting no capital growth, no inflation protection, because you're still actually only earning interest. But you sit on that for time and then you decide one day to sell it, and so typically that's the process. That's how a preference share works.
Speaker 3:The problem is that preference shares are not stable. Preference shares are not stable, so when people believe that the interest rate environment is volatile, then the price of the preference share becomes even more volatile. So for a lot of people they put money into their preference shares hoping for a very low risk kind of almost not quite, but almost guaranteed return, and then they put their 100,000 Rand in preface shares hoping to earn 7,500 Rand a year, and then all of a sudden the price of their preference share goes from 100,000 down to 80,000. And then they panic because they wanted a low risk, high interest or high interest, but actually dividend investment. So what we need to realize about pref shares is they are volatile investment. So what we need to realize about PrefShares is they are volatile companies. I think there's been some changes in the way that companies now issue Prefs because the structure or the treatment from a tax and accounting point of view of PrefShares has changed for businesses. So I think that their lesson is popular now for businesses and then for the people that normally would buy them, looking for low risk, stable return.
Speaker 3:Preference share can often be anything but low risk. It can actually be very risky without the prospect of serious capital growth. If you buy I mean let's just say choose a stupid example you buy pick and pay prep shares today and the interest rates go through the roof and your preference share goes down, you're getting no reward. You're getting some dividends, sure, but if you bought, pick and pay the company and it doubles in value, the volatility of the share price is offset by the potential for real capital growth. So I think preference shares are sort of fading into obscurity for a few technical reasons, but primarily for private investors. If you're looking for stability and certainty, then I think an RSA retail bond is probably a much better idea. It's not tax-free but at least it's guaranteed by government and the interest rates are high and then you pay a bit of tax, but you've got certainty. So I think, give preface shares a skip, but sure if they still trade, you can buy them on the stock exchange.
Speaker 3:Otherwise, your following questions about Altex and A2X. So Altex does exist on the JSE. I think it's still there. But the thing about Altex was it was designed to kind of cater for small companies that wanted to list on the stock exchange, and the idea was the JSE would make it cheaper, easier for small companies to list and then those of us as private investors who wanted access to small businesses trading on the JSC could find these good companies. The story for those Altex companies was quite good for a while because they were good high growth businesses.
Speaker 3:But what's happened since is we've had the blessed Jacob Zuma years where the economy got driven into a wall. Small businesses particularly really suffered, and so those small companies listed on the JSE really have had a hard, hard time and they haven't been delivering as a general rule, haven't been delivering much return for investors and often actually causing quite big losses. So I don't think there's a lot of interest anymore. And then to add to that, the JSC's promises of making it cheap and easy to list as a company. It was cheaper and easier than being a mega company listed on the JSC. But it wasn't cheap and it wasn't easy and the compliance was through the roof and the accountants and the lawyers were running the show and making it really difficult to kind of operate a nice business cheaply and effectively on the JSC. So they actually destroyed the business case for companies to stay listed. That's why so many of those businesses have delisted and gone elsewhere for their capital when they need to grow.
Speaker 3:The JSC is promising to try and find a new way again to make it attractive for small companies to list. You can probably gather I'm a little bit cynical now. I think they've made us lots of promises in the past. They haven't delivered and they're full of excuses. So I'll kind of suspend my disbelief for now and just watch. And if there's a good news story to tell, we'll tell it on Honest Money because we would love it, where small companies can list on the JSC and private investors can find ways to buy those high quality, high growth businesses just much more efficiently. So I guess watch the space, there's good news, we'll share it.
Speaker 3:A2x I'm not as familiar with. I think the answer really is that it's not really designed for private investors. It's actually designed for institutions to trade very large businesses in kind of batches and then they settle those trades with A2X and then A2X settles back at the end of the day with the JSC. So it's a bit of a technical thing, but you and me we're not the clients of A2X, it's pension funds, unit trusts and professional managers. I hope that helps. Thank you very much for the question. That was real high-grade stuff. I had to really rack my brains and please keep them coming.
Speaker 1:The Honest Money Podcast is brought to you by Prescient Investment Management. We consider everything to give you the advantage. It's the future of investing. Prescient Investment Management is an authorized FSP.