Treat hybrids with caution: van Eyk

The hybrid securities sector remains a heavily concentrated and risky market despite its general growth and positive returns, and presents a range of complex issues for investors according tovan Eyk Research.

An Australian Hybrid Securities Review released by the research house warns investors who have ‘piled into the sector’ to realise its particular risk characteristics rather than expect ongoing returns above 10 per cent.

The research house says that over the past two years hybrid fund managers and investors have enjoyed returns buoyed by a ready supply of hybrid issues, sound corporate balance sheets and falling interest rates.

However, van Eyk says the combination of these low interest rates, as well as weak stock markets and expensive property trust and mortgage securities that have benefited the sector, are unlikely to continue indefinitely.

Van Eyk analyst Nigel Douglas says that investors have stampeded into the local hybrid market as it has seemed a ‘port in the storm,’ offering almost a guaranteed eight per cent effective returns.

“It’s important for advisers and investors to realise that the sector is still developing, that managers have different styles, and are yet to experience the gamut of credit cycles which will fully test their risk and return strategies,” he says.

The sector review assesses theChallengerHigh Yield,JB WereEnhanced Income,SchroderHybrid andUBSHigh Yield funds which are available to retail investors, though none received an A (recommended) rating.

“We believe this result reflects the immature stage of development in the Australian market. The funds have limited histories and there is no performance record across the credit cycles,” Douglas says.

The review recommends investors diversify their hybrid exposure across multiple managers, to benefit from the various manager styles.

The UBS Hybrid index shows the sector is composed of 20 securities, with the top five securities accounting for 54 per cent of the index and one security alone accounting for 16 per cent of the index.