Hybrid securities are financial instruments that have both equity and debt features, and have been a key part of the Australian securities market retail product offering for many years.
For investors, hybrids offer regular interest payments at rates usually several percentage points higher than those paid on bank term deposits or ‘vanilla’ corporate bonds; while the potential equity convertibility is a more conservative way of holding exposure to a company.
While directly buying hybrids through an exchange such as the ASX can be a valid investment approach, it is important that hybrid holders, or investors looking to buy hybrid securities, are aware of both the risks and pitfalls in holding hybrid securities directly, and how an active approach may mitigate such risks.
In this guide, investors are encouraged to put their knowledge to the test, and to learn about the benefits of Australia’s first hybrids active ETF, which provides access to a professionally managed portfolio of hybrids.
Investing in hybrids
Hybrid securities have become a popular choice amongst Australian investors, and for good reason – hybrids provide attractive franked income returns which are typically higher than bonds and cash along with normally relatively low capital volatility.1
Hybrids are distinctive in that they have both bond and equity features and, as such, provide a unique diversification opportunity to investors along the risk-return investment spectrum.
However, along with these benefits, investors may well find that hybrids can be relatively complex securities to understand.
No two hybrids are the same
Perhaps one of the primary reasons behind the complexity of hybrids for investors is that no two hybrids are exactly the same. The terms of each individual hybrid can be different and some hybrids can include terms that are not always favourable to the investor.
These variable terms and conditions, along with other factors, can make it difficult for investors to properly assess the attractiveness or risks of investing in a particular hybrid security. In addition, as they are not nearly as well understood, investors may also find it difficult to properly evaluate the ‘fair value’ of their investment, compare one hybrid against another, and to take advantage of any buying opportunities, such as market mispricing, as and when this occurs.
Are your hybrids working with you, or against you?
Australian investors who hold hybrids directly tend to be aware of their benefits. However, many may not be fully aware of the potential risks and complexity that comes with holding hybrid securities directly.
Direct versus Actively Managed Hybrids
Hybrids are complex securities which can differ greatly in terms of their bond and equity characteristics – and hence their ultimate risk to investors. Failure to properly understand each hybrid security’s specific terms and conditions can result in some investors taking on unintended risks, or at least potentially forgoing better returns available on other hybrids with similar risk.
In addition, the relative inefficiency and make-up of the hybrids market allows experts to potentially take regular advantage of mispricing. Of the hybrids available on the ASX, the vast bulk have been directly purchased and are owned by retail investors – many of whom might not have the expert knowledge to pick and choose the best hybrids available.
While directly buying hybrids through the ASX can be a valid investment approach, we consider there are several advantages in accessing this exposure through an Active ETF such as BetaShares Active Australian Hybrids Fund (managed fund) – ASX:HBRD.
Benefits of Actively Managed Hybrids
One notable advantage of a managed fund structure is the ready diversification provided. Due to the administrative burden of holding many securities – especially within a portfolio of other investments – it may seem practical for direct hybrid investors to own only a small number of securities, which can give rise to company-specific risk and heightened return volatility more broadly.
Indeed, as hybrids are complex securities which can differ greatly in terms of their bond and equity characteristics, diversified exposure across many securities could help mitigate this risk, as well as spread the credit risk associated with each hybrids issuer.
HBRD will aim to provide diversification through a target holding of around 20 to 50 hybrid securities when fully invested, although the actual number may vary from this target over time depending on market conditions.
Downside Risk Management & Potential Alpha
Probably the most critical reason to gain exposure to hybrids through a managed fund structure – and especially one that is actively managed – is to mitigate downside risk and exploit potentially greater opportunities for “market beating” alpha.
Specifically, under an active management investment strategy, if and when the hybrids market is assessed to be overvalued or present a heightened risk of capital loss, there is a greater opportunity to allocate more of a portfolio to lower risk securities (eg senior bonds) and cash.
Finally, as is the case in the small cap area of the equity market – which is also relatively inefficient – the hybrids market can also be subject to significant mispricing over time, which a diligent and skilled professional fund manager should generally be able to exploit over time.
Compared to the sharemarket, the hybrids market is relatively illiquid. For example, the bid-offer spreads (i.e. the difference between the market price at which hybrids are able to be bought and sold) for Commonwealth Bank hybrid securities tend to be notably higher than those for its shares. What’s more, these spreads can vary greatly on a day-to-day basis – suggesting they can be highly influenced by the number of buyers and sellers on any given day.
As a result, while it’s possible for retail investors to get into and out of hybrid securities on the exchange, it can often come at a cost! Owing to their expertise and better “buying power” through greater volumes traded, professional fund managers have opportunity to trade hybrid securities on generally better terms (i.e. tighter bid-offer spreads) than that typically faced by retail investors.
Learn More About Active Management
In this BetaShares Insights, we explore how hybrid securities have proven popular with Australian investors and – until recently – investing in hybrids directly was the primary method available. Now, with another option available, we believe it’s important to understand the advantages of accessing this investment through a managed fund structure.
Watch our short video for more information on how HBRD can help investors navigate the hybrids market.
Watch our short video explaining why an active approach to managing hybrid securities can potentially deliver outperformance and reduce the risk of owing hybrids directly.
Christopher Joye, Co-Chief Investment Officer at Coolabah Capital - the investment manager of the BetaShares Active Australian Hybrids Fund (managed fund), outlines the common causes of mispricing in the Australian hybrid market and the impact this may have on investors.
BetaShares Active Australian Hybrids Fund (managed fund) – ASX:HBRD
HBRD is an Active ETF that provides investors with a convenient alternative to direct ownership of hybrids by offering access to a professionally managed, diversified portfolio of hybrid securities. HBRD is actively managed and aims to deliver returns that exceed the ASX hybrids market over time. You can buy or sell HBRD just like you’d buy or sell any share on the ASX.
There are a number of important advantages of HBRD, particularly for retail hybrid investors, but the five most important are:
5 Reasons to Invest
A PROFESSIONALLY MANAGED HYBRIDS EXPOSURE
HBRD provides access to an actively-managed portfolio of hybrids and seeks to reduce the volatility and potential downside risk that may be experienced by direct holders of hybrids.
MANAGE PORTFOLIO RISK
If, and when, the hybrids market is assessed to be overvalued, or to present a heightened risk of capital loss, the Fund can allocate more of its portfolio to lower risk securities, or even move entirely into cash.
DIVERSIFICATION IN ONE ASX TRADE
Instant access to a high-quality portfolio of hybrids to provide diversification to many investors who may otherwise own only a handful of hybrids directly.
ATTRACTIVE INCOME, PAID MONTHLY
HBRD pays monthly distributions and investors are expected to be entitled to franking credits that the Fund’s investment portfolio generates. Income levels are expected to be higher than cash and senior bonds.
Fund may benefit from access to superior liquidity compared to directly held hybrids; Fund trades on ASX like any share.
Investment Manager Monthly Commentary: October
HBRD returned 0.29% before franking credits and after fees in October 2020, ending the month with a net running yield of 2.57% (gross running yield of 3.56%). Over the last 12 months, encompassing the unprecedented COVID-19 shock, HBRD has returned 2.24% before franking and after fees, outperforming the RBA Cash Rate return of 0.37%, the Solactive Australian Hybrid Securities Index’s unfranked return of 1.98%, and the All Ords Accumulation Index’s loss of -6.51%.
Since inception, HBRD has returned an unfranked 3.91% after fees, with only an average 87% portfolio weight to ASX hybrids, relative to the Solactive Index’s 3.97% unfranked return and the RBA Cash Rate + 2.5% return of 3.55%. HBRD’s since inception volatility of 6.03% has been lower than the Solactive Index’s volatility of 6.48%. At the end of October, HBRD was diversified across 43 hybrids/bonds, had a 91.6% allocation to hybrids, 3.9% to subordinated bonds, and 4.5% to cash.
New hybrids from Challenger, Bendigo & Adelaide Bank and Bank of Queensland were launched during the month as expected, with Westpac marketing a new offer in early November. All transactions have come with attractive new issue concessions. NAB is expected to quickly follow Westpac to refinance a December maturity. At 320 basis points above the quarterly bank bill swap rate, hybrid spreads remain materially above pre-COVID levels and post-GFC tights.
How to invest in HBRD
- You can buy or sell units just like you’d buy or sell any share on the ASX
- Fund requires no minimum investment (your broker may require a low minimum, typically $500)
Submit the form on this page and receive a full product pack which includes the Investment Case for HBRD, Factsheet and other product information.
There are risks associated with an investment in the Fund, including interest rate risk, credit risk, hybrids complexity risk and sector concentration risk. For more information on risks and other features of the Fund please see the Product Disclosure Statement.
1 Hybrids have relatively higher risk compared to cash deposits.
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