Preference shares have been a popular equity allocation - sometimes the only allocation - in investment portfolios of Bermuda residents. They have quite often been thought of as a guaranteed sure thing (they are not - though see the local bank offering discussed below***), but then what is today? They have traditionally paid a higher dividend rate of return, than common shares, a very attractive feature during low interest rate environments.

Preference shares, or preferreds as they are also known, have also been a favourite for their issuers, public corporations concentrated mostly in the financial sector - banks and insurance companies. The preferred stock offerings are issued, usually, at $25 per share par value and trade in capital markets under normal circumstances within that fairly narrow range. They have been an alternative way to increase company capital without diluting common shareholder rights, although some versions can contain a right to convert to common shares. They seemed so reliable and dependable that often they were assumed to be much the same as a fixed deposit or being thought of as bond-like in their structure.

They were, generally, issued with a fixed dividend coupon rate, which meant once a quarter, almost without fail, a handsome quarterly dividend was paid. They often contained a callable provision date within the issuance offering, giving the issuer the right to "call back" the shares at par, leaving the investor to find a suitable replacement. The call back provision allowed the issuer, in a low interest rate environment, to redeem the higher paying dividend shares. A new share offering with a lower dividend rate would replace those called back - good corporate planning.

It is never all investment utopia in this narrow segment of the investment market, but overall, while these shares held their value, had minimal volatility and trundled on, everyone felt like sheer geniuses for making such a comfortable choice. When capital markets were fluctuating wildly, you really were not too fussed. When interest rates were low, their resale market value popped up above that call par value, acting inversely, again more like bonds.

Learning lessons. One of the biggest market events of our time was centered around the liquidity and credibility of major global financial institutions, along with other factors. Starting in August 2007, the uncertainty, rippled out in waves encompassing share values in many sectors and industries along the way, including the insurance and bank companies that we know and love.

Suddenly, the realisation - which was always there but slightly submerged - came to the fore (again) - that the current value of an investment in any market is only as good as the strength of the underlying company, government, municipality and so on. Concentrated in the financial sector, some preference shares were backed by companies that were perceived to be in crisis. Those stable values weakened and declined; some were lost as institutions such as Lehman failed.

Investors made varying decisions. Some headed for the hills, redeeming out of these preferred shares, while others have remained more optimistic, willing to absorb unrealised losses (on paper). As the US market has recovery has slowly progressed, the small investor felt if they continue to hold, over the longer term, these investment will be again what they once were.

Recently, Citibank announced that they had offered investors holding their preferred shares a chance to convert to common shares. Described as a positive move for the company given that there are millions of shares outstanding, the savings alone on the dividend component is significant. This option means that means that while the investor may no longer receive dividends, the common shares will have unlimited opportunity to increase in value. The exchange offering, which closed on July 23, 2009, is 96 pages long, more than enough to put most people to sleep mid-way.

Further, this conversion will change the nature of an individual investor allocations, and risk factor while reducing the income generating component of the portfolio. This is a good time to contact your financial advisor for a review of your entire financial profile.

***The recent preference share offering by one of our local banks was guaranteed by the Bermuda government. In reality, since we are the financial supporters of the government, you and I, Bermuda residents and tax payers are guarantors by virtue of our future earnings and investment in the Bermuda economy. We are our own guarantee.

Martha Myron, CPA CFP™ (US) TEP JP, is an independent fee-only qualified financial planner who specialises in comprehensive solutions for internationally mobile people and Bermuda residents with US connections in the areas of tax, retirement, estate, business entities and investment planning. Confidentially contact Partner at Patterson Partners Ltd. - mmyron@patterson-partners.com, 441 296 3528 or martha.myron@gmail.com">martha.myron@gmail.com