One of the latest Exchange Traded Products to be launched by Betashares, the Betashares Australian Hybrids Fund (HBRD) tackles the complex and often poorly understood space of hybrid shares. Offering a fund that invests in a diversified portfolio of Hybrids, Betashares are hoping to tap into investors’ demand for yield, something promised from Hybrids.
Hybrids are complex beasts, and one must read the fine print behind each offering to truly understand them. The name comes from them being hybrid between debt and equity meaning they share some of the characteristics of bonds and some of the characteristics of shares. They generally offer to pay a fixed rate of return to the investor (like a bond), but their price can move up and down (like a share).
The devil tends to be in the detail, however, and hybrids generally have some of the longest Product Disclosure Statements (PDS) known to man. Commonwealth Bank’s latest PERLs offer (their hybrid product) had a PDS that was 122 pages long. There’s a lot of complexity in these products.
Below Betashares attempts to explain hybrids in plain English.
At ETF Watch we’ll be tracking this new fund as an ETF, however, HBRD is an Exchange Traded Managed Fund (ETMF), meaning it has many of the same qualities of an ETF, however is actively managed. We took a look at and explained ETMF’s some time back. Since then the popularity of ETMFs has really increased and we expect to see further ETMF listings in the coming year.
In Australia most hybrid securities are offered by our big banks. They do this to sure up their capital base, essentially to ensure they remain solvent even in the worst of times. The majority of HBRD’s exposure is in these bank hybrids, with 96.6% of exposure to bank hybrids. The top 10 holdings include hybrids issued by all of Australia’s big 4 banks.
The main attraction to hybrids tends to be their high income yield which generally is returned to the investor fully franked. Most of the hybrids out there today are offering around the 5-7% grossed up yield (including franking credits), as a result we’d expect to see income yield of HBRD of around this mark. Hybrids generally offer a yield around 20-25% lower than a bank’s shares, but the promise of lower volatility. HBRD is targeting volatility of 3%-4%pa, around one third of the historic volatility of the Australian share market. It’s this yield and low volatility that has seen hybrids being so popular with self directed investors, particularly SMSF investors, however there are risks which are often not understood, more on this below.
Investors are often drawn to Hybrid securities high yields and promises of low volatility and see them as a low risk way to earn a high income yield. Often the devil is in the detail. The biggest risk of hybrids tends to be what will happen in a black swan type event. In an event where a bank is in trouble, hybrids can be converted to equity or written off by the bank without pushing the bank into default. In a way, the high yield offered is an insurance premium against the worst happening. Perhaps if this was to happen, losing your investment may be the least of your worries, as it would likely mean a serious economic meltdown was underway, but it is something worth considering.
One of the other key risks is the upside risks. Whilst hybrid investors receive a nice fat dividend, they don’t share in the price upside that a shareholder in a bank would. Any investor in Commonwealth Bank’s float in the 1990s will tell you that at an initial share price of $5, their many multiple return over the years has been a combination of good dividend yield and share price accumulation. Hybrid investors will get the yield, but not the share price upside.
It is because of the above that many critics of hybrids say they give you the worst of both worlds, limited upside in the good times, and unlimited downside in the bad times.
HBRD will not actually be managed by Betashares, with the company outsourcing management to Coolabah Capital Institutional Investments, a manager who specialises in managing hybrid securities. As we mentioned earlier, HBRD is an actively managed fund, meaning they are actively aiming to outperform the index they follow, the Solactive Australian Hybrid Securites Index. Management fees are 0.55% pa, with a performance fee of 15.5% of performance beyond the benchmark. HBRD will provide monthly distributions.
HBRD is the first ETF available in Australia that targets this space. As a result, for those who don’t want to go to the effort to understand the complex individual hybrid issues, HBRD may be a suitable option. There is a small LIC which focuses on hybrids, the Australian Enhanced Income Fund (AYF). AYF only has a market cap of $20m, and has low liquidity, however, may be an alternative for investors interested in this space.
For those wanting exposure to general bank shares, rather than hybrids, Vaneck offers their Australian Banks ETF (MVB), which invests in all the big banks. For those looking for exposure to more general fixed income investments, there’s now a range of ETFs available, which can be researched on the ETF Watch Fund Database.