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™

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 Viridian Select Pty Ltd ABN 41 621 447 345, AFSL 51572

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