ASIC urges caution on hybrid securities

The Australian Securities and Investment Commission (ASIC) has urged consumers to ensure they understand the conditions and risks of hybrid securities and unsecured notes before committing their money.

ASIC Chairman Greg Medcraft said: "Retail investors may be attracted by the interest rates offered by household name companies and trusted brands, but hybrid securities should not be confused with government bonds or 'vanilla' corporate debt. In some cases investors are taking on equity-like risks but only receiving bond-like returns".

Hybrid securities have higher risks than most types of corporate bonds. While the conditions, timeframe, risks and interest rates (coupons) of each hybrid offer differ, they also carry some complex features and risks, including price volatility.

Like company shares, the market price of listed hybrid securities may fall below the price that the investor originally paid. Relatively small changes in credit spreads can have a big impact on the market price of long-term hybrid investments.

For example, using a simple calculation for an investment with 40 years until maturity, paying 8 per cent per annum, a change in credit spreads from 8 per cent to 9 per cent could see the market value of the hybrid reduce by 11 per cent overnight.

Another key characteristic to be aware of is their subordinated ranking. Hybrid securities are generally unsecured notes, meaning that repayment is not secured by a mortgage or security over any asset.

If the company issuing the hybrid securities becomes insolvent, hybrid investors generally rank behind senior bondholders and subordinated bondholders. 

"We want to ensure consumers are fully informed before they invest," Mr Medcraft said. "This includes understanding when a company is allowed to defer or suspend its interest payments and what the rights of the investor are to terminate early."

To help address some of the issues with hybrids, ASIC lists five important questions that prospective investors should ask their broker or adviser. These include:

"What are the risks of investing in this hybrid security? 

"Will the returns offered adequately compensate me for the investment risks? 

"How does the interest rate compare with other investments on a 'risk adjusted' basis and can other less complex, risky or long-term investments provide a similar or better return? 

"Will this product help the investor achieve their personal goals and objectives, and does it suit their investment timeframe and risk profile? 

"Can investors exit the investment if their circumstances change?"