Exploring Options with Morgans Noosa
Mention hybrids and you may think of a certain Japanese car maker. John Caruso recently discovered the existence of hybrids in the financial world, revealing a potential path to profit.
Feeling lost in the investment jungle? Drowning in a sea of confusing options, each promising riches but whispering hidden risks?
Fear not intrepid explorer! Today, we’re venturing into a fascinating corner of the financial world: the alluring realm of hybrids!
Think of them as the adventurous cousins of your trusty term deposit, offering a taste of the stock market’s thrill without the full-blown rollercoaster ride.
These are no ordinary investments, they’re a unique blend of debt and equity, offering a chance at higher returns than your average savings account, but with a dash of risk.
“Hybrid is a generic word to describe what are known as Tier 1 Capital Notes,” explains Matthew Auger, Stockbroker and Partner with Morgans Noosa.
“They have features of both equity and debt, hence the term and you’ll find that the big four banks, plus some smaller banks, insurance companies and annuity companies all issue hybrids.
“They sit above shares and below bond holders and they’re deemed riskier than cash in the bank because cash is covered by the Commonwealth Government Guarantee, however hybrids are not as risky as ordinary shares.
“There’s volatility associated with ordinary shares that we don’t see with hybrids, and we saw that during the pandemic.
“For example, ordinary shares of Commonwealth Bank fell 40%, but their various hybrids only fell between 10 to 20%; plus banks are obliged to pay dividends on their hybrids ahead of ordinary shares and that makes them a little safer in terms of continuity of income compared to ordinary shares.
“That’s one of the reasons why hybrids are particularly attractive to retirees.”
The Financial Services Royal Commission that ran from the end of 2017 to 2019 determined that the industry needed to examine a client’s needs, situation and objectives.
“For retirees, hybrids tick all the boxes,” says Matthew. “Their situation is that they are retired so their need is to draw or generate an income with their self-managed super fund to pay themselves; and their objective is to generate enough income to cover that pension payment, so hybrids offer that perfect vehicle for that portion of our clientele.”
Some of the terminology tossed about within the financial world can be confusing. Getting Morgans Noosa to guide you through the jargon makes sense, especially when we’re talking about your hard-earned nest egg.
“A ‘call date’ in the context of hybrids or capital notes is like a ‘due date’,” Matthew says. “It’s a specific date when the bank has the option to pay back the money you invested – however the bank isn’t required to do this, it’s just an option.
“So, if you invest in a hybrid, the call date is the earliest date you might get your initial investment back. In the case of the big four banks, they’ve always called their hybrids in on that first call date, they’ve never let them go through to the mandatory conversion date which is when your investment might change from being a hybrid to becoming ordinary bank shares.
“Generally, on that call date they offer a new hybrid that you can roll into if you want. For most of our clients they just want the income stream so they’re happy to hold them and keep rolling them over into the next issue at each call date.
“Hybrids have been around for about twenty years. We’ve got some clients who’ve been through three to four rollovers and they’re happy collecting that income with dividends paid quarterly.
“The payments comprise cash and franking credits, as per the terms of the prospectus and if a bank can’t offer full franking on a hybrid dividend it has to increase the cash amount to compensate.
“This is a key benefit compared with owning ordinary bank shares where if the bank cuts franking levels, then it’s tough luck to the ordinary shareholders.”
Hybrids trade on the ASX so they can be bought and sold via a broker like Morgans Noosa. They’re typically issued for $100 each and you simply buy them on the ASX, paying the market price at the time of purchase.
The advice from Matthew is that hybrids don’t really offer capital growth.
“If you want capital growth and the associated risk of capital loss, then stick with ordinary shares,” he advises.
“Since hybrids trade on market and go up and down, they suit investors with a medium to long term timeframe.
“If you are looking to park cash for six months, stick with a term deposit.”
So, intrepid explorer, have we navigated the hybrid jungle successfully?
Remember, like any financial adventure, there’s always an element of risk so seek your own independent advice before you invest.
With the right knowledge and a touch of courage, hybrids can be a valuable addition to your investment portfolio, offering potential growth and income while keeping your feet (mostly) on solid ground.
