In God we trust (here's why)
by Doug Brodie
In this blog
What’s in a rate?
Understanding preference shares
/1. What’s in a rate?
In chatting with Ali, the Sunday Times journalist, he wanted to know what rate of income our client could and would be getting. “Well, I said, that depends”. To us that’s a bit like asking the question “How much is a house?” or “Should I get a car?”. There are many, many different variants. Merchants Trust has a yield today of 5.12% whilst Mercantile Trust is 3.6%, Aberdeen New India is 0% and SLF Realisation Trust is 283%.
A quick search with Mr. Google for savings rates threw up adverts from the above five banks, amongst many others. We always recommend that depositors only use banks they know, only banks they have heard of, because otherwise there is a residual nagging uncertainty once an account has been opened. These banks don’t have branches, which means to deposit money you have to send money through the internet, inputting your personal details, pressing a button to ‘send’.
Don’t get me wrong, I’m no luddite and have happily banked with the branchless First Direct for many years. The point we make here is that rates are not straightforward - you clearly get higher deposit rates if you’re happy dealing with a virtual bank where you have no chance of meeting any staff, never mind a friendly bank manager.
When building a portfolio one needs to take account of the different features of a trust’s yield: Merchant’s pays a high initial yield (5.12%), and F&C’s yield is low (1.58%) and Mid Wynd even lower at 1.02%.
A slightly disturbing reality for all of us is we will either need continued reliable monthly income in ten years’ time or we’ll be dead (in which case it doesn’t matter). Inflation guarantees that a pint of milk will cost more in the future, so we need to ensure the income grows for you. Merchants Trust’s annual income growth rate over the past 10 years is a lowly 1.64%, whereas Mid Wynd came in at an inflation-crushing 11.61%.
/2. Understanding preference shares
And then there’s preference shares: these are designated as shares in a company, however the ‘preference’ part is because they are legally structured like company debt (borrowings).
The classic example is a preference share issued by Aviva, called the 8 ¾% cumulative, the latter tag meaning that the interest due on it (the 8 ¾%) is a cumulative debt to Aviva and can never be missed – just like the interest on an interest-only mortgage.
The 8 ¾% is the ‘coupon’ on the share, it is a fixed dividend that is guaranteed by Aviva, a company worth £10.5 billion on the stock market. For every single preference share of £1, Aviva pay each year 8.75p, so what’s not to like? Why doesn’t everyone buy these instead of Aviva’s ordinary shares, which yield 8.06p per £1?
The answer is that to buy £1 of those preference shares you need to pay £1.19p, and that fixed 8.75p is then 7.35%, because you have paid £1.19 for the same fixed coupon, not £1.
And then there is the real reason why this is not suitable for investors to buy off the shelf: preference shares are subject to contractual prospectus terms that attach to them, and retail investors are highly unlikely to be able to find those documents, or to read them, or to understand them.
In three days in March 2018 these prefs lost 30 per cent of their value when Aviva stated to the market that it was going to buy back those shares at the issue price of £1, when the market price at that day was £1.46p.
Aviva said it “had the ability to cancel preference shares at par value (£1) through a reduction in capital, subject to shareholder vote and court approval”.
Aviva had found a clause in the small print in the prospectus that they believed let them get away with it, wiping out the premiums that most investors had paid in order to secure the income. Cutting to the end of the story, the FCA and government waded in and Aviva did a very public, humiliating U-turn.
A core reason of that change was the behaviour of another issuer of preference shares, Ecclesiastical Insurance Group. They have £106 million issued in a preference share with an 8 5/8% coupon, which is currently priced at £1.24 so yields 6.98%. It’s non-cumulative, meaning that if the board decided they need to skip an interest payment for whatever reason, they don’t have to make it up in the future.
Ecclesiastical insures churches (amongst other things). In response to Aviva’s attempt to use a loophole to redeem its irredeemable prefs, Ecclesiastical publicly stated:
" … as one of the biggest companies in our sector, we aim to make our industry work better for everyone. That starts with us building trust with our customers, investors and shareholders by running our business honestly and transparently."
Aviva’s own prospectus describes the shares as ‘non-redeemable’ – any other interpretation than that is simply a weaselly attempt to knowingly stiff the shareholders; God’s insurer said honesty is all, and surely now its prefs must be as safe as houses. (Or should that be churches? Ed.)