The benefits of investing in ASX hybrids

Companies aren’t always looking to issue shares (equity) in order to get their hands on cash; if they believe strongly in their business model and the economic environment surrounding it, they’ll want to hold onto as much of their ownership as possible. So, as low interest rates promote growth and recent economic uncertainty begins to fade, it is logical to assume companies will use debt to accelerate their growth. However, in the absence of an easy-to-access retail corporate bond market, companies need alternate ways to directly access the end investor, and this is where Australia’s relatively-advanced sophistication among retail investors kicks in.

If a Rivkin member seeking an income investment comes to us for general advice, we’ll generally look for retail-friendly, liquid investments for them to trade, so they don’t get caught up in a structure that is too complicated or cumbersome. Complication breeds fear, and we target simplicity to combat that fear and cater for a family of relaxed, happy members. So rather than point them in the direction of retail sovereign and corporate bond markets, we favour the familiarity of exchange-listed hybrid securities – they look like an equity, trade like an equity, and we can employ bottom-up equity research to ensure they’re paying the right amount of income for the risk involved.

ASX Hybrids

Given the size and quality of issuers recognising the ease with which hybrid securities allows them to connect to retail investors, the ASX hybrid market is one that we believe has reason to grow. Here are some of the characteristics of the ASX-listed hybrid securities market:

  • 30 ASX-traded hybrids listed by 21 different issuers, amounting to around $19 billion in capitalisation
  • Very strong representation in financial services, with that sector representing over 40% of the hybrid market (ANZ, CBA and Westpac all have issues, with NAB’s first hybrid coming online in March this year)
  • Income payments to investors are typically made quarterly or semi-annually
  • The majority of hybrids are perpetual, meaning that there is no fixed redemption date
  • Most issues (but not all) at the low end of investment grade, having preference over shareholders but subordinate to bondholders
  • Retail-friendly – the same $500 minimum marketable parcel as listed shares
  • The vast majority of hybrids pay fully-franked payments, which means they are ideal for low-paying tax structures, such as self-managed superannuation funds
  • Adequate transparency due to the availability of data on the (primarily) listed underlying companies.

As you can see, these securities have many characteristics of a bond; the difference being that if you have some cash in your trading account right now, you can jump online and buy them just like you do with shares.

How Rivkin handles hybrids

Diversification is important when trading hybrids, as significant events that occur in the underlying business can significantly impact the face value of the listed hybrid.

Rivkin Local manages a model portfolio made up of approximately 30% dedicated to income securities, which include a combination of issuers. The average yield on this portfolio is 7.7% (as at 17 December, 2014) and it is actively managed, meaning that if we buy a hybrid at a big discount to market, we’ll sell it when it becomes fair value. Or, if our analysis on the underlying company forecasts any issues that might affect its ability to service the income payments, we’ll get rid of it and go looking for something else.

Conclusion

As cash looks for ways to flood the economy via low interest rates, and growth picks up, debt will undoubtedly become more popular, reversing at least some of the deleveraging associated with credit market freezes after Lehman Brothers collapsed and banks battened down the hatches in 2008.

While most investors are out there ‘buying retail’ with investments in the banks, insurers and property trusts that are presently benefiting from the flight to yield, the listed debt markets are still lying in the shadows of their issuers, to a larger extent. So rather than just focus on income from fully-paid shares or take up brand new hybrid issues, we hunt around in the secondary hybrid market for opportunities where our members can ‘buy wholesale.’

If consistently analysed and presented in a portfolio with the right dynamics, hybrids present a great alternative to waning cash/term deposit rates or variable dividend policies.

Complex product warning

This article contains information about hybrid securities, which are considered complex financial products. Please click here to read the ASX's "Understanding Hybrid Securities" document before considering an investment in hybrid securities. 
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DISCLAIMER: Rivkin aims to provide clear and simple information to those visiting our website. If any part of this disclaimer does not make sense, please phone Rivkin and ask to speak with a member of our Dealing and Relationship Management Team. Rivkin provides general advice, securities and derivatives dealing services and accounting administration services. Rivkin does not provide advice that takes into account your, or anybody else's, investment objectives, financial situation or needs. We strongly suggest that you consult an independent, licenced financial advisor before acting upon any information contained on this website. Investing in and trading securities (such as shares listed on the ASX) and/or derivatives (such as Contracts for Difference or 'CFDs') carry financial risks. CFDs carry with them various additional risks that differ from more simple securities such as fully-paid company shares. Some of these risks include not owning the underlying instrument from which a price is being derived, settling trades 'over the counter' with a financial institution rather than on a stock exchange, and using leverage to gain access to trades that may have a higher face value than your initial deposit. This risk of leverage means that it is possible to lose more than your initial investment. Our aim is to create more life choices for our clients, which means improving the wealth of clients throughout many market cycles by nurturing a relationship spanning many years. If you are not comfortable with your understanding of the risks involved before using a Rivkin product and service, please contact our office to seek further information or a Product Disclosure Statement, or make an appointment to sit with one of our friendly financial experts. It is in our interest for your Rivkin experience to be a rewarding and comfortable one. Rivkin is a trading name of Rivkin Securities ABN 87123290602, which holds Australian Financial Services Licence No. 332 802.