Understanding the Split Personality of Split Actions

What is happening with Canadian Life Companies Split Corp.? Did class A shares (LFE) just reduce their dividend to zero?

The short answer is yes. But to understand what happened here, we need a quick lesson on split stock corporations. These complex investment vehicles are marketed to retail investors looking for income, but they can bring unpleasant surprises, as we will see.

Split-stock corporations, of which there are dozens in Canada, have a basket of common shares that pay dividends. In the case of Canadian Life Companies Split Corp., the portfolio consists of four of Canada’s largest life insurers. Other split-stock corporations invest exclusively in banks or energy producers, for example, while some have a diversified basket of dividend stocks across different sectors. There are even split stock corporations that have shares in a single company.

To raise money to buy their dividend stock portfolio, split stock corporations sell two classes of stock to the public: split preferred stock and split equity stock. Each has its own structure and personality.

Split preferences are the more stable and predictable of the two classes. They are usually first in line for dividends generated by the underlying stock portfolio. Upon liquidation of the split-stock company (securities generally have a termination date that is often extended), the preferreds also have first claim on the capital of the portfolio, up to a certain amount (equivalent to the share price). issuance of preferred shares). Thanks to these built-in protections, Preferred typically provide a high level of security, but minimal growth potential. That makes them appropriate for conservative, income-oriented investors.

Canadian Life Companies (LFE.PR.B) Split Preferred Stock currently yields about 6.3 percent, and the shares have paid uninterrupted monthly dividends since their issuance in 2005. The market price of the preferred stock has also risen. remained fairly stable, despite a strong pandemic. -Related crash in March 2020, from which stocks have fully recovered.

Equity shares (also known as class A shares), on the other hand, have a different structure that makes them much less predictable. In exchange for forgoing most or all of the underlying portfolio’s dividends, Class A shares are entitled to all capital above the fixed portion allocated to the preferred shares. This makes equity shares effectively a leveraged play on the underlying portfolio.

The leveraged structure is great when stock prices are rising, because the equity shares experience an even higher gain. But when the underlying shares are falling, the loss is magnified for equity investors.

Equity shares also pay dividends, which are funded in part by the sale of call options on the stock portfolio. But class A dividends, unlike split preferred dividends, are anything but stable. Split stock corporations typically suspend class A dividends when the portfolio’s net asset value falls below a certain level.

That is precisely what happened with the Canadian Life Companies Split. On March 18, Quadravest Capital Management Inc., which manages this and other split-stock companies, announced that no dividends would be paid on Class A shares that month. That’s because, under the terms of the prospectus, regular monthly dividends are suspended “as long as the net asset value per unit is equal to or less than $15,” Quadravest said in a press release. Specifically, as of March 15, the NAV per unit was $14.30. By March 31, it had recovered to $14.80. (Split Class A and Preferred shares are initially issued as a unit, but then begin trading separately; NAV per unit refers to the combined value of both classes of shares.)

On its website, Quadravest says that one of the “highlights” of class A shares is the “specified monthly cash dividends.” But anyone who buys the stock to generate income is likely to be disappointed: Over the past two years, the stock has declared a grand total of 20 cents in dividends — 10 cents in January and February of this year. Going back five years, Class A shares paid dividends in just 13 of the 60 months. Also, the stock price is lower today than it was five years ago. Not all Class A split stocks have such a terrible dividend history, but late payments are not uncommon, especially during tough periods for the stock market.

Now, if life insurance stocks start to rise, equity stocks should do well because of their leveraged structure. But that is an unknown. What is clear is that, for this particular split-stock corporation, preferreds have been the best bet.

As with any security, make sure you understand what you’re getting into before you invest.

Email your questions to jheinzl@globeandmail.com. I can’t personally respond to emails, but I choose certain questions to answer in my column..

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