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Awareness of hybrid risk a must

The risk associated with hybrids – debt securities with characteristics between a bond and a share – needs to be understood by individuals before they are included in an investment portfolio, a senior executive specialising in fixed income has said.

“If you’re holding hybrids as fixed income or as defence, they’re not defensive assets. You’ve got to treat them like shares and that’s a really important point,” FIIG Securities education and research director Liz Moran warned delegates at the Australian Shareholders’ Association Conference in Sydney in May.

“So you should be looking at them and your overall allocation in terms of what they are to the banks and I would include hybrids as a share.”

Moran pointed out conditions dictating how hybrids were treated by their issuers, mainly the banks, were a good indication as to how risky they were.

“We already know that with the capital trigger clause that converts them into shares and the non-viability clause that also converts them into shares,” she said.

“It means at the worst possible times they are meant to support the bank so that the bank can repay its bondholders and continue to survive.

“This is a really important point. They are loss-absorbing instruments and that is what APRA (Australian Prudential Regulation Authority) calls them.”

According to Moran, the regulator had stipulated to the banks “you are to issue loss-absorbing instruments to help you in difficult times” in reference to hybrids.

In addition to the associated risk levels, she cautioned investors to understand why an investment in hybrids was being recommended at all, particularly if it was to replace an existing allocation to those types of assets.

“Is it being recommended by your stockbroker? They’re getting a commission so they want you to sell out of the old one and buy a new one, but the new one is going to be longer dated, it’s going to have different terms and conditions to the old one and you really need to do your homework before you say yes,” she said.

“If you’re going to get say an additional 1 per cent return, then 1 per cent may not pay you for the additional risk you are undertaking.”

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