OpenMarkets Education

Hybrids

Hybrid securities provide a means for banks and companies to borrow money from investors in return for interest payments; a hybrid security has characteristics of both debt and equity securities.
> The debt-like feature is the promise to pay a rate of return, which can be fixed or floating, until a given date.
> The equity-like features might include the potential for the security to be converted into equity or the security holder being subordinate to other creditors in the event of liquidation.

The hybrid securities quoted on ASX can be broadly divided into three categories:
1. Convertible notes – debt securities that can be converted into equity securities at a predetermined time
2. Preference shares – equity securities with debt-like features; preference shareholders generally have a claim on a company’s profits and assets ahead of ordinary shareholders in the event of liquidation
3. Capital notes – a short term debt security issued to help cover liabilities, or in the case of bank, ensure they meet their capital requirements.

As with any investment structure, there are both positive and negative aspects of investing in hybrids.

PositivesNegatives
The receipt of an income stream for a pre-determined timeCertainty of cashflow can vary according to the hybrid structure
Income is generally higher than that paid by fixed income securitiesGenerally considered a high-risk investment; hybrids are subject to credit risk, liquidity risk and equity market risk
Portfolio diversificationSome hybrids allow the company to suspend interest payments for several years, leaving you temporarily out of pocket
Some hybrids allow the company to terminate or 'buy back' the investment early, but do not give investors that same right

It’s said of hybrids that they have ‘bond like returns with equity like risk’…in other words, do your homework and make sure the hybrid’s risk profile matches yours

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