Are SMSF Investors really comparing Hybrids vs. Company Shares?


 

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Every article I  read at the moment the commentators are more and more sceptical about the recent issues of Australian listed hybrids and notes. They constantly compare the hybrid against the equity in the actual shares of the issuer.

And yes I have been saying to younger clients who wanted to invest that I personally would buy the shares of the blue chip issuers, not the hybrid, because the successful hybrid issue shifts risk from equity investors to the hybrid investors and if you are going to take long-term risk then get recompensed for it from the  issuer.

Yet the majority of people buying these hybrids are not my younger clients and they probably don’t look at the case for hybrids vs. shares. They are my SMSF Retiree and Pre Retiree clients. They look at the investment case of hybrids vs. their HISA (High Interest Savings Accounts) rates and term deposit rates. I know from these clients the majority of the demand for Australian hybrids has come from maturing term deposits and falling interest rates as the RBA cuts.

The banks and their advisers have worked out these “yield plays” seem to be in favour and hybrid issuance is increasing as term deposit and cash rates fall. They are tempting clients to put some of their “defensive portfolio” in to this sector rather than trying to grab some of the Share portfolio allocation.

Commentators say that the banks who are the main issuers are getting the best deal and yes their ratings have been improving when they finalise these issues.

They recommend that you buy the Shares in these companies rather than the “mutton dressed up as lamb” hybrids.

Christopher Joye in the SMH provided the following as an example where he compared the results using CBA PERLS IV vs. CBA Shares themselves over the period July 2007 to July 2012. Yes, with hindsight, you would be far better off owning the shares but they miss the point. Regardless of the outcome many SMSF trustees have a lower risk tolerance and they would be content with the returns from the PERLS IV (25.4% over 5 tumultuous years) during that period while they may have had a meltdown if in the CBA shares during the highlighted volatile period July 07-Mar ’09.

The other point I should make is that clients are making much smaller risk adjusted plays in these hybrids by quality issuers only and are willing to hold to maturity. When they have  a $100K Term Deposit maturing they are placing 10K-30K in to one or two of these hybrids and putting the rest back on Term Deposits. It is recognition that these hybrids do carry more risk and that they understand that risk.

Their aim is not to attain equity like returns but an average portfolio income in the 5.5-6% mark and that can no longer be achieved by cash and TDs alone. So yes they are taking on more risk to achieve their objectives but they are not being silly and getting over exposed. That is why we have avoided Crown, Caltex, Bendigo & Adelaide and even SunCorp issuances.

So yes the Banks get the benefit of cheaper finance but SMSF investors get access to that yield, in bite sized manageable chunks that they require with less volatility than the underlying share. The risks in hybrids are not to be scoffed at but if you do your home work, understand the risk, keep the allocations small and think long term, then they may have a place in your portfolio.

If you want to read more about hybrids generally, the ASX has produced a guide – Understanding hybrid securities – that you can download here.

Are you looking for an advisor that will keep you up to date and provide guidance and tips like in this blog? Then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

Understanding bonds – Guidance for SMSF Trustees


What is a bond?

A bond is simply a loan between two parties.

A person who buys a bond is the lender of money at a fixed rate of interest. The borrower is the organisation, which issues the bonds. Issuers are usually government bodies or large corporations.

Organisations issue bonds as one way of financing operations – the Australian government has used bonds to fund road projects.

Like any loan, the borrower must attract investment by offering interest on money lent. Bonds are issued with a guaranteed fixed interest rate for a set period of time.

When that period expires, the investor’s original capital investment is returned. The original investment is known as the “face value” of the bond. The interest rate is known as the “coupon”.

The date of expiry is known as the “maturity date”.

For example, on 1 July 2010, the Australian Government issues a 10-year bond with a face value of $1000 and a coupon of 5 per cent.

The bond owner will receive an interest payment – paid by the Australian Government – of $50 per year (5 per cent of $1000) for the next 10 years.

On 1 July 2020 the investor will be paid back the bond’s face value of $1000.

Once issued, bonds are traded on an exchange and purchased or sold by individual investors, fund managers and other institutions. The price of the bond may change depending on demand and supply of buyers and sellers in the market.

How do bonds work?

A bond’s price may change when it’s traded on an exchange but its face value, coupon and maturity always remain the same.

Any change in price will also change a bond’s yield – or the return on the bond based on its current price.

For example, a bond with a face value of $1000 and a coupon of 6 per cent (or $60) has a yield of 6 per cent. This is determined by dividing $60 by $1000.

But if the price of the bond rose to $1200 investors would still receive a coupon of $60 – pushing its yield back to 5 per cent ($60 / $1200). If the bond was to fall to $600, the yield would rise to 10 per cent ($60 / $600).

This explains why a bond’s yield falls when its price rises, and why its yield rises when its price falls. It also explains why a bond investor who sells prior to the maturity of the bond may experience a loss on the capital value of their investment if long term interest rates rise. Conversely they may sell at a gain if long term interest rates fall.

Are you looking for an advisor that will keep you up to date and provide guidance and tips like in this blog? Then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Top 50 Logo 12%

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

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