Small Fry: Australian Hybrids
Australian investors searching for yield have shown a strong appetite for hybrid securities issued by banks and other financial institutions, particularly in the low interest environment of recent years. But while these securities may offer a higher return than some bonds, they are not a free lunch.
As the name suggests, hybrids combine elements of debt and equity. Like bonds, they typically promise to pay a rate of return (fixed or floating) until a certain date. But hybrids also have equity-like features.
These features include uncertainty about the timing and amount of income payments and the potential for the securities to be converted to equity. Holders can also be adversely affected by early repayment or being left subordinate to other creditors in the event of insolvency. This optionality, which is generally to the benefit of the issuer, is embedded in the price of the hybrid.
But regardless of the wisdom of whether or not to invest in hybrids, there are also questions about the size of the allocation, which should be a function of each investor’s goal and whether an allocation to hybrids will help them achieve those goals.
A good place to start here is with the market portfolio. The exhibit shows that as of November 2023, the total global investible universe of stocks and bonds was around AU$207 trillion. By comparison, the ASX hybrid securities market was worth $0.04 trillion or just 0.02% of the global market portfolio.
The implication here is that it is very easy for an Australian investor in hybrids to be left with a disproportionate exposure to a market dominated by a few banks. For example, a 1% hybrid allocation would equate to an overweight by a factor of about 45, based on the numbers above.
Coming with their own risks, hybrids are small fry in the much bigger and diverse investment world. They’re not even a free snack, never mind a free lunch.
Small Fry: Total Australian Hybrid Market Value
As of 31 November 2023 in Trillions
This article originally appeared in Short N Sweet, a newsletter for Dimensional clients.
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