Preference shares have proved an efficient alternative investment for individuals seeking a relatively high and stable source of income.

Preference share dividends aren’t taxed, often making them the preferred investment class of tax-sensitive wealthy investors.

Company shares should be bought for the expected ongoing dividend flow. Where preference shares are different is that they aren’t part of the company’s equity.

Issuers typically use the proceeds to shore up balance sheets, making preference shares a debt instrument, something like a corporate bond.

The holders of preference shares also enjoy some rights above ordinary shareholders.

But the selling point is that the dividend is set when the preference shares are issued, either at a fixed or floating rate linked to the prime interest rate.

That gives investors reasonable certainty of how much money they’ll receive.

Yields are currently far better than money market rates, in the region of 7.5% to almost 10% – tax-free. That makes preference shares a sound investment to beat inflation at relatively low risk.

SA’s Big Four banks were the first to issue preference shares, linked to the prime rate in proportions between 63% and 80% of prime.

All the other banks – Investec, Sasfin, African Bank Ltd and Capitec – have also issued preference shares.

So have some large companies listed on the JSE, such as PSG, Steinhoff, Grindrod, Netcare, Imperial and Astrapak.

Much like corporate bonds, the bank preference shares tend to attract better credit ratings but offer lower yields than corporates.

With interest rates possibly at or near the bottom of the cycle, now would be a good time to invest in preference shares.

Choosing the right share depends a lot on the investor’s needs and is a little like stock-picking on the JSE.

However, the easiest route could be to invest in a preference share unit trust fund, three of which are available on the market from Coronation Fund Managers, Investec and Grindrod Bank.
 

 - Finweek