An investment in a hybrid security has the potential to provide investors with a regular income stream. Many hybrid securities also offer benefits not available from traditional interest-paying investments such as term deposits.
Hybrid securities can have the following advantages:
- pay a defined income stream
- generally return their face value at maturity
- enable you to diversify your investments
- are bought and sold on ASX
- may offer tax advantages.
Different hybrid securities can have very different characteristics and typically carry greater risks than most types of bonds. Investors should take care to inform themselves about the specific characteristics of a particular hybrid security before making a decision to invest.
Differences between simple bonds and hybrid securities
Simple bonds are debt securities that pay a fixed or floating rate of interest on pre-determined dates and have a right to have the face value of the bond repaid at maturity.
Hybrid securities are considered hybrid because they combine features of both debt and equity securities. For example, a convertible bond typically combines the features of a simple bond with an option to convert it to a share (an equity security) at some point in the future. Whilst ever that option is well “out of the money”, the market price of the convertible bond can be expected to perform similarly to a simple bond paying an equivalent return, but as the option gets closer to being in the money, the value of the option will reflect more heavily in the market price of the convertible bond.
For those hybrid securities that combine the features of a simple bond with an embedded option, the relationship to a simple bond can be thought of as follows:Simple bond + option = hybrid Simple bond = hybrid - option Hybrid - simple bond = option
You can see from the above formulas that a hybrid security with an option attached will intrinsically have a different value than a simple bond. The option itself has value, which may be positive (where the option is exercisable by the holder) or negative (where the option is exercisable by the issuer), and thus the hybrid’s price will reflect this embedded option value.
The simple rule to remember is that if a security contains any feature that enables it to:
- be changed into a different security (be that at the option of the issuer or holder);
- have its payment structure amended; or
- have its security ranking downgraded;
then the security is considered by ASX to be a hybrid security. Perpetual and complex debt securities (for example a bond that might be heavily subordinated), are also considered by ASX to be hybrid securities as they have features that are more akin to equity securities than debt securities.
Investing via ASX's interest rate security market
ASX's interest rate security market gives investors easy access to a market where they can buy and sell hybrid securities in the same way as they buy and sell shares.
The market provides investors and their advisers with ready access to information about the price, return (yield) and ratings of different hybrid securities and facilitates comparisons with other securities.
Go to the list of hybrid securities and their prices on the ASX website.