Question:

I have always considered preference shares had two attributes compared to ordinary shares in that they have more assured dividends and should be less volatile.

ASB, Origin Energy and RaboBank have all issued preference shares in the past two years that have dividend annual reset rates based on one-year swap rates. This, I recognised, would limit the prospect of capital gain, but I assumed that the capital value of the shares would stay close to par. Not so. The capital values presently are: ASB, 72 per cent, Origin Energy, 63 per cent and Rabo, 82 per cent of par value.

Can you advise what the market conditions would be whereby I could expect their values to move closer to par?

The obvious answer is "when swap rates rise". However, I have a nasty
feeling that general rates will also rise and the capital value of these
preference shares is likely to remain heavily discounted. Is there hope
or have I been conned?

Answer:

Mary Holm: There's hope, but don't hold your breath. As to whether you've been conned, that depends on what you were told when you bought the preference shares.

To put others in the picture, preference shares generally fall between bonds and ordinary shares in risk and volatility, so the returns should also be in between. They are usually perpetual - meaning they have no maturity date. To get your money back, you need to sell the shares.

If the company gets into trouble, preference shareholders stand in line after bondholders but before ordinary shareholders.

Traditionally, preference shares paid a fixed dividend. But recently issuers have tended to regularly reset the dividend rates, as you describe.

"A few years ago, some companies issued them when there was a shortage of bonds, and so the margin they offered was low given the risk," says Michael Chamberlain of SuperLife.

Since then, interest rates have risen, so the value of the preference shares has fallen, pushing up their future expected returns to reflect their risk. "For them to move back to par, the markets would again have to be tight," says Chamberlain.

He concludes that you probably paid too much for the preference shares. If he's correct, it will take another shortage of better alternatives for their value to rise to par - their original issue price. It could be a long wait.

Even if the preference shares had been priced better, Chamberlain doesn't like them. "No investor should buy perpetual bonds or preference shares. The only way to get your money back is to sell them," and therefore pay transaction costs. You also run the risk the market price will be below par, as it is now. By comparison, if you hold ordinary bonds you get your money back at maturity and pay no brokerage.

Mary Holm is the author of bestselling books on KiwiSaver and personal finance. She is also a highly praised seminar presenter. Her written advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following that advice.