David Carruthers (Head of Credit and Core, AMP Capital)
The ongoing search for income has led some investors to turn to hybrid securities. While these securities present an alternative source of income that is often higher than cash, they also come with additional risks and structural complexities. As such, hybrids require careful analysis to determine whether the return provided is sufficient compensation for the risks that investors bear.
5 things investors need to know about hybrid securities
1. Not all hybrids are created equal: Some hybrids will behave more like shares, and others more like bonds. Even though banks and other financials dominate issuance, investors should consider that each type of hybrid security has a unique risk and reward characteristic.
2. Hybrids can be highly volatile: Like shares, the market price of listed hybrid securities may fall below the price that the investor originally paid, especially if the company suspends or defers interest payments, or if its performance or prospects decline.
3. Hybrids are generally less liquid than shares: This means that there are fewer buyers and sellers in the market for this type of investment and investors that need to sell quickly, may have to accept a lower price.
4. Hybrids are often unsecured: Repayment of the initial capital or ‘principal’ is not guaranteed. In a wind-up scenario, hybrid investors are among the last to recover their funds.
5. Hybrids can be complicated: It is critical that investors fully understand all the terms and conditions as these will have a signifi cant impact on whether the hybrid meets expectations.
Investors that value a steady return and capital stability may fi nd hybrids unsuitable. Overall, we do not believe hybrids should be relied upon by investors as the sole source for a consistent and foreseeable income stream.