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What's Your Preference?
Friday 2, March 2018

What’s your preference?

Toni-anneF

Bonds and shares are the two main classes of assets investors use in their portfolios. Shares offer an ownership stake in a company, while bonds are akin to loans made to the issuer, which may be a government (sovereign bond), a company (corporate bond), and so on. In general, shares are considered riskier and more volatile than bonds. However, there are many different kinds of shares and bonds, with varying levels of volatility, risk and return.

This comparison offers a basic overview of plain vanilla bonds vs. preference shares so that you can make a more informed decision when incorporating them in your portfolio.

Preference shares

A share represents part ownership of a business. A company can raise money to finance its business by 'going public'. Going public means being listed on a stock exchange and issuing shares to investors. By paying for the shares, each investor buys part ownership of the company's business and becomes a shareholder. Preference shares have a fixed dividend that must be paid before any dividends can be paid to common or ordinary shareholders. Unlike common shares, preference shares generally do not carry voting rights.

Bonds

A bond is a fixed income investment in which an investor lends money to an entity (typically corporate or governmental) who is borrowing the funds for a predetermined time and a predetermined rate. Bonds are used by companies, municipalities, states and governments to raise money to finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.

Similarities and differences

Holders of preference shares and bonds are both entitled to regular distribution payments. Bondholders are entitled to the receipt of regular interest rate payments, while holders of preference shares receive regular dividend payments.

However what a lot of people don’t realize is that unlike bond payments, which are mandatory, owning preference shares does not guarantee dividend payment. Preference shares can be cumulative or noncumulative. For cumulative shares, if a corporation fails to pay a dividend, that dividend amount is owed at some point in the future. The shares accumulate outstanding dividends to be paid when the company makes a profit. For noncumulative shares, a dividend is lost if it is not paid. So if you are investing in preference share please find out if they are cumulative!

People invest in shares with the objective of generating wealth either through potential share price growth, via income paid as dividends or a combination of both. If the company performs well, you can benefit from share price growth and/or income paid as dividends. Equally, if the company performs poorly, your shares could decrease in value and/or the company may pay no dividends.

It is important to understand that shares are often very long-term investments (10+ years), usually for retirement purposes. In any given year, the shares of a particular company can have steep highs and lows as its value is redefined again and again on the market. As a result, shares are generally considered to be riskier and more volatile than bonds however they are also believed to offer a generally higher return than bonds.

Bonds are also used for retirement savings, but shorter-termed bonds can just as easily be used throughout a lifetime for small, periodic returns. Many people invest in bonds for the income via interest payments, but often forget that bonds like shares can also benefit from price appreciation and can be sold for a profit to generate capital gains.

In the Jamaican market, investors may find it difficult to sell preference shares issued by a local company if they need back their cash. If you are concerned about the liquidity of your investment it would therefore be better to invest is a bond that trades on the international capital market, as there is a ready market for those bonds.

Sometimes companies fail and have to close down or reorganize. In the event of bankruptcy or liquidation, preference shareholders receive payment only after the company settles its debt. This means that bondholders have an advantage over shareholders when it comes to liquidation. Shareholders receive any money that is left over after debt repayment, which may not be any at all. This is one of the biggest reasons bond investments are generally safer than investments in shares. However it likely that neither bondholders nor shareholders will back all of their investment, which proves yet again the importance of making careful, well-researched investments.

Toni-Ann Elliott (formerly Neita) is the AVP, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback:  If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

 

 

 

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