Income investing remains one of the primary investment goals for a lot of investors, particularly retiree’s. So not surprisingly, the boom in listed bank issued ‘hybrids’ continues unabated, with new issues popping up at regular intervals.
These investments are particularly attractive to SMSF trustees and retiree’s portfolio’s alike. As an investment paying a regular income stream and has the imprimatur of a big bank, is just too good to be passed up.
Both banks and insurers issue these ‘hybrids’ so they can raise money for their regulatory capital requirements. With the proceeds being contributed to a mandatory cash buffer provided for the protection of the financial system.
But here’s a word of caution to those looking to do some income investing. All is not what it seems with these products. For example, did you know that ‘hybrids’ are actually designed to be “loss-absorbing”? Simply put, this means the investor, and not the bank, has all the risk of suffering a loss.
As a result, this actually pushes the product much higher up the risk ‘ladder’ than what is usually perceived by the average investor. And there is no statutory bank guarantee to fall back on either, as happens with the usual bank deposit up to $250k.
Therefore, this type of investment should never be considered as belonging alongside your standard bank deposits or bond investments. These ‘bad boys’ behave very differently, and all depending on a range of factors totally outside the investor’s control.
Just ask anyone who has read the associated Product Disclosure Statement (anyone?). They would have discovered it contains a complex series of events, tests, conditions and approvals that even experienced investors would find pretty difficult to understand. In other words, there are more hoops to jump through than a circus act.
For example terms such as Discretionary non-cumulative distributions, meaning interest payments are not guaranteed and any missed payments don’t accumulate or Subordinated, which means if the issuer goes insolvent, you get don’t get paid until just before shareholders, which in effect is right at the end. Good luck with that one!
And there’s plenty more of this terminology scattered through the Product Disclosure Statement. All of which paints a picture of an investment that is carrying far more risk than your average in- come producing term deposit.
Here’s a few more to get your head around.
Scheduled conversion or mandatory conversion – The hybrid will convert into ordinary shares in the issuer on a fixed date, usually, 8-10 years after the hybrid is issued, provided that the issuer’s ordinary share price has not fallen by more than 50% in that time.
Optional redemption, resale or transfer – The issuer can repay your investment (or in some cases, convert it to ordinary shares) early if they meet certain conditions and receive regulatory approvals. This can occur on one or more fixed dates, typically beginning 6 years after the hybrid is issued, or any time there is a change to laws or regulatory requirements affecting the hybrid.
Perpetual – Despite a number of terms specifying when your investment can be repaid or converted into shares, capital notes, and convertible preference shares have no fixed maturity, which means your investment may never be repaid.
Unsecured and not guaranteed – The issuer does not guarantee your investment will be repaid, and unlike savings accounts or term deposits with a bank, hybrids are not covered by the Government guarantee. And the investment is not secured by a mortgage or security over an asset.
Income investing – Be careful
So, as always with these ‘engineered’ investments, the risk ramifications only really become apparent, when, and if something happens. Unfortunately, by then it’s too late. Oh, by the way, if some- thing does go haywire, and you do complain, that’s when you hear the infamous bank response “I’m sorry but it was in the terms and conditions!”
So for those running SMSF’s just be aware that investing in this type of instrument is far from risk- free and they should be seen as belonging to your risk assets rather than as a risk-free income-producing asset. What seems a straightforward investment is actually skewing your portfolio towards a much greater risk weighting than what you would probably want.
And for you retiree’s, looking at doing a bit of ‘bank backed’ income investing, stick to term deposits. If you feel the offer is too good to miss, the old investing rule of “no more than 10% of your investing assets” should always apply.
Thanks for reading, see you next time. Homepage
