A hybrid security is one that combines two or more securities to form a single investment. They are usually traded on markets such as the Australian Stock Exchange (ASX) and are often used by companies as a way of borrowing money from investors.
For example, a typical hybrid security may be part debt and part equity, which means that they generally carry significant risk for investors while yielding only bond-like returns.
As a concept, this sounds simple enough, but in reality, hybrid investments have a tendency to become highly complex. Although these investments offer a specific income for a fixed period, they can change their structure by converting into their underlying equity. Even some of the most financially savvy trustees grapple with their characteristics.
However, hybrids are growing in popularity and one of the main reasons is that each hybrid is structured differently, so they offer great diversity. Additionally, investors enjoy both a predictable cash flow – sometimes in the form of a franked dividend – and the potential for capital growth because of the equity component of hybrids.
If you are considering a hybrid investment for your SMSF, take into account the following points.
Volatility. As with other equity investments, share price movements may be reflected in the value of a hybrid security.
Unfavourable ranking. If the company issuing the security becomes insolvent, there is no guarantee that investors will receive any money. This is because investors generally rank behind creditors and senior bondholders.
Long timeframes. It’s not unusual for a hybrid security to have an investment timeframe of 20 years or even more. Selling the hybrid may be possible, but only if there is a demand for that particular security. Further to this, the longer the term, the higher the risk of the underlying company experiencing financial difficulties.
Some questions trustees should ask before investing in a hybrid include:
- What are the current and future risks of this hybrid security?
- Are the returns worth the risk?
- Is there an alternative investment that provides a similar return?
- Does this security meet the SMSF’s goals and objectives?
- Does the maturity date suit the SMSF’s investment strategy?
According to the Australian Financial Review, the Australian Superannuation and Investments Commission (ASIC) issued a warning on the risk of hybrid securities. It’s reasonable to say, therefore, that trustees thinking about investing in hybrid securities should seek professional advice and ensure that they fully understand the conditions of the investment prior to signing on the dotted line.
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