What are preference shares?

Preference shares are sometimes known as ‘convertibles’ or ‘hybrids’ because they have characteristics of both equity and debt.

Like bonds, preference shares provide regular and defined income payments and generally have a fixed maturity date.

However, as with ordinary shares, the income from preference shares comes in the form of dividends, which will either be paid at a fixed or floating rate.

Example:

A company launches a convertible preference shares issue, paying floating rate dividends with an annual margin of 3.25%.

That ‘margin’ of 3.25% would be paid on top of the benchmark rate, such as the bank bill rate, at the time of each dividend payment. The bank bill rate was around 2.6% at issue, representing an annual dividend of 5.85%, but could have moved up or down by the next payment date.

Preference shares are generally converted into ordinary shares at some point in the future, although some issuers reserve the option to pay cash instead.

As a preference shareholder, you rank ahead of ordinary shareholders in the queue to be paid dividends or for claims on the company’s assets if it goes out of business.

How to buy preference shares

When companies issue preference shares, they publish a prospectus to go with it, outlining all of the important features, risks and other considerations.

You can apply to buy preference shares directly from the company or you can buy them through a broker once they are listed on the ASX.

If you buy them on the stock exchange, you will pay the market price, as you do with shares and bonds, rather than the issue price.

Selling preference shares

Most preference shares, if you hold until their maturity date, will be converted into ordinary shares, usually at a discount to the market price at the time.

But if you sell preference shares before they mature, you’ll have to sell them on the ASX and accept the market price at that time, which may be above or below their face value.

All preference shares vary in terms of structure and risk, and like with any investment it’s important to fully understand them before investing.