How much runway is left in ASX hybrids? | BetaShares

How much runway is left in ASX hybrids?

BY Christopher Joye | 23 February 2021
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In this guest post, Christopher Joye, Chief Investment Officer of Coolabah Capital Investments, the investment manager of the BetaShares Active Australian Hybrids Fund (managed fund) (HBRD), takes a look at the ASX hybrids market, and whether hybrids currently represent good value.


With Macquarie launching the first ASX hybrid issue for the year on 15 February, perfectly timed to coincide with the day NAB repaid its $2 billion NABHA security, it begs the question: How much further can ASX hybrids spreads (and hence prices) rally? 

ASX hybrid spreads have certainly come a long way. Prior to the COVID-19 crisis, Coolabah’s proprietary, constant maturity major bank 5-year hybrid curve was sitting at about 275 basis points (bps) over the quarterly bank bill swap rate (BBSW). In 2019, 5-year major bank hybrid spreads were sitting as tight as ~260bps over BBSW.

During the COVID-19 shock, 5-year spreads blew-out to well over 800bps above BBSW, which was a record high: hybrids were cheaper than we had ever seen them before despite the fact that the major banks had aggressively de-levered their balance-sheets since the GFC and divested riskier non-core businesses.

Heading into the COVID-19 crisis, Coolabah sought to de-risk HBRD through an elevated cash and bank senior bond portfolio weight of ~15% with just an 85% exposure to hybrids. As hybrid spreads exploded in March 2020 to their highest levels ever, Coolabah acquired more than $300 million of these assets across all our portfolios (including HBRD) at significant discounts, as others raced for the exits. The Solactive ASX Hybrids Index is now up 26% from its low in March 20201.

HBRD ended March 2020 with a 99% portfolio weight to hybrids and outperformed the Solactive ASX Hybrids Index by 1.7% after fees (before franking) in that month (noting this short term past performance figure is not indicative of longer term or future performance for HBRD). More information on HBRD’s performance is provided later in this article.

How much runway is left?

The first chart below shows Coolabah’s historical 5-year major bank hybrid curve, and we can see that the post-GFC lows for spreads are around ~235bps above BBSW. We continue to believe major bank hybrid spreads will test their post-GFC nadir. Currently, 5-year spreads are trading at 270bps, which is still 10bps wide of their 2019 lows of 260bps, and some 45bps wide of where they could head if they pass through their post-GFC trough in 2014.

Chart 1: Major bank 5-year hybrid spreads vs. BBSW

Major bank 5-year hybrid spreads vs. BBSW

Source: Coolabah Capital Investments. Past performance is not indicative of future performance.

For a 4.5-year duration hybrid, that implies there is capital gain upside of over 2% if we converge back to 2014 spreads, on top of the income these securities pay. Today that income equates to a total running yield for a new hybrid issue of about 2.7% p.a.2

Prior to the GFC, 5-year major bank hybrids were trading at around 125bps over BBSW. While the contractual terms of today’s hybrids differ materially to their 2007 predecessors, and expose investors to greater risks of a theoretical bail-in event, Australian bank balance sheets carry substantially less leverage and risk than what they were burdened by in 2007. CBA’s common equity tier one capital ratio in 2007 was less than 5%; today it is over 12%.

Our central case is that 5-year major bank spreads are likely to push through their post-GFC lows of ~235bps towards the 200bps area over time.

Another way of looking at hybrid valuations is to consider their credit spreads as a multiple of safer and even more liquid securities issued by the same banks, which sit higher up the capital structure. The second chart below tracks the multiple of 5-year major bank hybrid spreads to 5-year major bank senior bonds, on a constant maturity basis over time.

Chart 2: Major bank 5-year hybrid spreads vs. 5-year major bank senior bonds

Major bank 5-year hybrid spreads vs. 5-year major bank senior bonds

Source: Coolabah Capital Investments. Past performance is not indicative of future performance.

Historically, hybrids have traded on a multiple of about 4 times senior bond spreads. Yet since the COVID-19 crisis, this has blown out to about 10 times, implying that these securities are unusually cheap. This is because 5-year senior bond spreads have been crushed by the RBA’s circa $180 billion term funding facility, which has meant that banks have not had to issue much senior debt, in turn putting downward pressure on senior spreads.

There are several risks to the outlook. We could get a tsunami of new hybrid supply given where spreads are today, although with a total of 5 new deals issued in the final quarter of last year, we think that is unlikely in the near-term.

We were forecasting Macquarie would issue this quarter, and think that a major bank could easily follow suit soon. But that is relatively modest supply in the face of the $2bn of NABHA cash hitting the system, which, coupled with the repayments in March of existing Macquarie and Westpac hybrids, should mean that search for yield remains robust.

There are other risks, including the possibility of escalating tensions between China and the U.S. over Taiwan, and a surge in senior bank issuance in late 2021 and 2022 forcing some mean-reversion in the abovementioned valuation metrics.

The BetaShares Active Australian Hybrids Fund (managed fund) (HBRD)

HBRD recently passed the ~$1 billion in Funds under Management (FUM) milestone.

Over the 12 months to 15 February 2021, HBRD beat the Solactive ASX Hybrids Index by 0.68% after all fees (before franking).

Including franking, HBRD returned 6.11% after all fees over the year to 15 February 2021 compared to the Solactive ASX Hybrids Index’s 5.80% return.

Since inception in November 2017 to 15 February 2021, HBRD has returned 4.24% p.a. unfranked (5.21% p.a. franked), matching the Solactive ASX Hybrids Index’s unfranked return despite being only 87% invested in hybrids over this period, with the remaining capital invested in cash and higher-ranking bonds3.

HBRD’s annualised volatility from inception to 15 February 2021 has been 5.77%, materially lower than the Solactive ASX Hybrids Index’s 6.20% annualised volatility over this period.

Of course, it’s important to remember that past performance isn’t indicative of future performance.

There are risks associated with an investment in HBRD, including credit, liquidity, the complexity of hybrid products, and sector concentration risk. Hybrid securities have complex and unique terms of issue and may involve higher risk when compared to some other fixed income investments. For more information on risks and other features of HBRD, please see the Product Disclosure Statement, available at www.betashares.com.au. An investment in HBRD should only be considered as a component of a broader portfolio.


1. As at 15 February 2021. Past performance not indicative of future performance.
2. Provides an indication of expected current income from making an investment at market price. This value will vary over time.
3. The period since HBRD’s inception to 15 February 2021 is approximately 3 years and 3 months.  For completeness, it is noted that the annualised performance for HBRD over the three years to 15 February 2021 was slightly lower than that of the Solactive ASX Hybrids Index.

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