ASX hybrid securities are financial instruments listed on the Australian Securities Exchange (ASX) that combine features of both equity and debt securities. These hybrids offer investors a blend of the characteristics of bonds and shares, providing unique benefits and risks.
Understanding ASX Hybrids
Hybrid securities can take various forms, including convertible bonds, preference shares, and capital notes. The commonality among these forms is their dual nature: they provide fixed income like bonds but also offer the potential for capital appreciation similar to shares. This blend aims to attract investors looking for higher yields than traditional fixed-income products but with more stability than pure equity investments.
Convertible Bonds: These are bonds that can be converted into a predetermined number of shares of the issuing company. Investors initially receive regular interest payments, but they have the option to convert the bonds into equity if the company performs well.
Preference Shares: These shares pay fixed dividends and have priority over common shares in the event of a company’s liquidation. However, they usually do not carry voting rights.
Capital Notes: These are unsecured, subordinated notes that offer higher yields but come with greater risk. They typically have a call date, after which the issuer can redeem the notes at their discretion.
Benefits of ASX Hybrids
Income Generation: One of the primary benefits of hybrid securities is their potential for regular income. Investors receive fixed or floating interest payments, which can be attractive in a low-interest-rate environment.
Capital Growth Potential: Convertible bonds, in particular, offer the potential for capital gains. If the issuing company’s stock performs well, investors can convert their bonds into shares, potentially profiting from the appreciation.
Diversification: Hybrid securities add diversity to an investment portfolio. They can reduce overall portfolio risk by providing exposure to both fixed-income and equity markets.
Tax Advantages: In Australia, some hybrid securities offer tax benefits. For instance, preference shares often provide franked dividends, which can lead to tax credits for investors, enhancing after-tax returns.
Priority in Liquidation: Preference shares and other hybrid securities usually have a higher claim on assets than common shares if the issuing company goes into liquidation. This priority can offer a layer of protection for investors.
Our team are experts in trading hybrids for institutional traders, we have a wealth of data and knowledge in the area and are constantly identifying value in fresh hybrid trades on a daily basis. If you’d like to join us, click here to find out more.
Risks of ASX Hybrids
ASX hybrid securities are complex financial instruments that combine features of both debt and equity. Here are some of the key risks associated with investing in ASX hybrid securities:
Liquidity Risk: There are generally fewer buyers and sellers in the market for hybrids compared to regular shares or bonds. This lower liquidity means you may have to accept a lower price if you need to exit the investment quickly.
Interest Payment Deferral Risk: Some hybrids allow the issuer (usually a bank or company) to defer or skip interest payments if they face financial difficulties. Missed interest payments may or may not accumulate depending on the terms.
Subordination Risk: In the event the issuer becomes insolvent, hybrid investors rank below senior bondholders and depositors to be repaid. There may be little or no residual value left for hybrid holders after other creditors are paid.
Conversion/Write-off Risk: Many bank hybrids can be converted into the issuer’s ordinary shares or written off completely if a pre-defined capital ratio trigger is breached or the issuer becomes non-viable. This can result in a partial or total loss of capital invested.
Long Maturity/Extension Risk: Hybrid securities often have very long dated maturities of 30+ years or can be perpetual (no maturity date). The issuer may choose not to redeem the hybrids at the first call date, extending the investment term further.
Credit/Default Risk: Unlike bank deposits, hybrids are not guaranteed by the government. Investors face the risk of the issuer defaulting and being unable to meet interest payments or repay principal.
So in summary, while hybrids offer higher potential yields than regular bonds, investors need to be compensated for bearing higher risks related to liquidity, subordination, deferral of interest payments, conversion to equity, and potential capital loss. Thorough analysis of the terms and risks of each hybrid security is essential before investing.
Our team are experts in trading hybrids for institutional traders, we have a wealth of data and knowledge in the area and are constantly identifying value in fresh hybrid trades on a daily basis. If you’d like to join us, click here to find out more.
Michael Cornips is the Managing Director and Founder of Emerald Financial.
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