The cost of insurance is a sentiment indicator that our Canadian Preferred Share Research team created for the preferred share market. The cost of insurance is the yield spread between a company’s rate reset preferred share and that same company’s rate reset preferred share with a floor feature. The insurance is how much an investor is paying up to remove interest rate risk for investing in the preferred share market. We calculate the cost insurance by calculating the spread on an issuer-by-issuer basis and then taking an average for the group. When the spread is positive it means that rate reset preferred shares yield more than a rate reset with a floor, and when the spread is negative it means rate resets with a floor yield more.
The cost of insurance continues to plunge in 2021, which historically, combined with rate reset preferred shares pricing in a 5-year yield higher than the market, is usually a sign that trouble is coming. The expectations in the rate reset market have pushed the cost of insurance to the point where insurance is cheap. What puts us at ease is that we are at the bottom of the interest rate cycle, which means over the long-term, rates will be higher and preferred shares should do well. But preferred shares could still be exposed to a sell-off in the near term due to large variations in opinion on whether inflation is transitory or not. The number of companies with negative insurance spreads has jumped to ten, with Artis REIT being the new addition. Minimum floor coupon preferred shares continue to appear fairly valued with only a 1.2% upside with a dividend yield of 5.1%.
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