Answering a Wake-Up Call

01/05/2010 9:42 am EST

Focus: GLOBAL

Tom Slee

Retired- Financial Advisor, Money Manager, Gordon Pape Enterprises LTD

The preferred, floating-rate shares of Canada's top telecom offer safety and yield for a post-Dubai world, writes Tom Slee in The Income Investor.

[In November,] Dubai stunned international investors by defaulting on its debt. The seemingly wealthy United Arab Emirate suddenly declared a six-month moratorium on state-owned Dubai World's outstanding loans. It was the global high finance equivalent of a homeowner running out of cash and skipping his mortgage payments. It was also the biggest sovereign default since Argentina went under in 2001. Markets reeled. Bond prices plunged. If Dubai, "an oasis of prosperity," could fail, nothing was safe.

Now, a few weeks later, the problem seems to be contained. Oil-rich Abu Dhabi is going to bail out Dubai. The Emirates have closed ranks, so what is there to worry about? Well, in fact there is a lot to worry about.

The damage has been done and it's already affecting small fixed-income investors. For a start, Standard & Poor's has downgraded Dubai-based banks. Other Dubai state-related bonds have been reduced to junk status. Because of mark-to-market requirements, that means international banks are writing down their balances with these institutions. There is a continuing ripple effect.

At the same time, investors have been backing away from the market, becoming more selective. One major bond issue has been cancelled and a flood of money that was starting to fuel the economy is once again backed up into US Treasuries. The cost of insuring Dubai debt has quadrupled.

The message is clear. Remain defensive. Keep your fixed-income portfolio heavily weighted in investment-grade issues with maturities of less than five years. This is not the time to reach for yield, however attractive it looks.

BCE is Canada's largest telecom with more than 7.3 million access lines, six million wireless subscribers and 1.9 million video customers. The company also provides broadcast and media services through 15% owned CTV Globemedia.

BCE's First Preferred Shares, Series Y (TSX: BCE.PR.Y) have priority over common shares with respect to payment of dividends and distribution of assets. The Series Y shares also rank in every respect on parity with every other series of BCE First Preferred Shares. The company has a strong balance sheet and impressive track record of stability and growth.

Interest rates are currently at record and, we think, unsustainable lows. Therefore, they are likely to rise and this will trigger increases in the Series Y share dividends, which float with an annual rate equal to 80% of Prime, adjusted monthly. These dividends are safe and should provide investors with increasing income during 2010 and beyond as rates rise. BCE can redeem the shares at any time at a price of $25.50 in cash. This very unlikely call would provide investors with an immediate capital gain.

Floating, adjustable dividends, currently equal to 56 cents per annum, are payable monthly. This high-quality investment offers security [and] safe income and acts as a hedge against rising interest rates. There is also the possibility of a capital gain.

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