For the year to the end of November, the FTSE/JSE All Share Index (Alsi) was down 12.26%. The FTSE/JSE Preference Share Index, by contrast, had gained 13.12%.
This is a dramatic reversal from 2017. Last year, the Alsi gained 20.95%, while the Preference Share Index fell 3.29%.
This poor return from preference shares on the JSE in 2017 was extremely challenging for local preference share funds. The CoreShares Preftrax exchange-traded fund (ETF) was the year’s worst-performing ETF.
The two local unit trusts that focus on preference shares – the Nedgroup Investments Private Wealth Preference Share Fund, and the Bridge Diversified Preference Share Fund – also produced disappointing overall returns. The Nedgroup Investments fund was marginally positive for 2017, but the Bridge portfolio ended the year down.
One of the greatest benefits of preference shares is however that their performance tends to show very low correlation to that of the stock market. This has been clearly illustrated over the last three years.
As the table below shows, the returns from the Preference Share Index and the Alsi have differed noticeably since the start of 2016.
|Total index returns|
|FTSE/JSE All Share Index||2.63%||20.95%||-12.26%|
|FTSE/JSE Preference Share Index||18.81%||-3.29%||13.12%|
This illustrates how preference shares can add meaningful diversification benefits in a balanced portfolio. They tend to deliver strong returns when stock markets are weak.
This has very much been the case in 2018. From being among the worst-performing funds last year, preference share funds are topping the performance charts for 2018. Both the Nedgroup Investments Private Wealth Preference Share Fund and the Bridge Diversified Preference Share Fund showed returns of over 15% to the end of November.
The chart below shows how, over the last three years, their performance has consistently diverged from that of the Alsi.
The other great benefit of preference share funds is that they tend to produce a consistent and reliable dividend income. The Bridge unit trust delivered a yield of 9.93% over the past 12 months, while the yield on the CoreShares Preftrax has been 10.67%.
Investors will receive this income regardless of the price movements of the underlying shares. Reinvesting the dividends compounds returns for long term investors, but can also be a useful part of an income-producing portfolio post retirement.
This is because these distributions are taxed at the dividend withholding tax rate of 20%. This is lower than the income tax rate for anyone in anything other than the lowest tax bracket.
The varied returns in these funds over the last three years is also a good lesson for investors who think they can spot a coming year’s top performers. They show quite clearly how one year’s returns are no indication for what will happen in the next.
It is not that unusual for the bottom performers one year to be the top performers the following year. That is exactly what has happened with preference share funds from 2017 to 2018.
Similarly, if anyone had invested in preference share funds at the start of 2017 based only on their strong performance in 2016, they would have been deeply disappointed. They would probably also have sold out at the bottom and missed the strong rebound this year.
What is far more important than just looking at performance numbers is understanding how different funds generate those returns. That helps you to understand how they can fit into a diversified portfolio and what you can expect from them in future.