Hybrids deliver returns comparable with equities over the long term with less volatility, which makes the risk-adjusted return and lack of correlation to equities an attractive characteristic in a diversified portfolio.
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Amid the many strategies proposed to overcome Labor’s franking policy if adopted, often overlooked is building a portfolio of the right types of bonds and hybrids as an alternative source of income.
While property and equity markets remain expensive by historical standards, yields achievable relative to risk remain strong in the hybrid market, notwithstanding recent upticks in price.
Almost every hybrid has a unique structure, and some of the conversion terms, especially following a ‘loss absorption’ event, are as ugly as a cane toad. Billions have been issued recently as investors search for income.
The increases in margins on Australian listed hybrids are prompting investors to ask whether the returns finally match the risks. Hybrids come in many forms so watch the finer details.
The Bank Bill Swap Rate (BBSW) is an important metric in many markets. It’s used as the benchmark for hybrids, FRNs and billions of dollars of loans and bonds.
With the current low interest rates, many investors are building exposures to hybrids unaware of the risks. Check the warnings of legendary investor, Ben Graham, and consider if hybrids can withstand a downturn.
Demand for bank hybrids paying margins of 3% above the Bank Bill Rate remains strong, although there is little sign that underlying interest rates will increase any time soon.
Until recently, institutional investors did not buy many bank hybrids, leaving issue size and margins subject to retail demand. But retail investors, including SMSFs, no longer have the market to themselves.
The search for yield has driven retail investors into billions of dollars of hybrids that could not be sold to wholesale investors at these levels. Is the full picture being told to the retail market?