Hybrid Securities

Julia said:

Bill, I wasn't questioning your choice. Just curious about why you prefer the hybrids to ordinary shares.

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I am at a stage in my life where I need less stress and worry. By owning common stock, a simple bit a bad news can halve the share price overnight. I do not like the stress of watching stock prices go down fast and I don't want to risk big capital losses.

With hybrids, convertible notes and floating rate notes the prices are more stable. Whilst they do go up and down the volatility is no where near as bad as common stock. They also pay regular incomes, even through the GFC all my hybrids paid the interest and I like regular income.

I also have enough cash not to want to chase high capital gains. I am happy loaning my money out at 6 to 8% to a company and get regular income. I have a portfolio of hybrids all paying me decent income.

Sometimes hybrids are not priced correctly, i.e. sometimes under face value or someone wants to offload a heap at a lower price. When this opportunity arises you have a chance of making capital gains as well. I do buy and sell some of my hybrids and make capital gains. It is not as good as the gains made from common stock but a few hundred here and there on top of the regular income is good for me.

I own and monitor several hybrids, when prices are not right I buy, when they run too hard up I sell. Sometimes they drop back again and I buy in again. I have bought and sold the same hybrids several times over. It is something I like doing and I make money from it.

In summary, I do not want the extra return for the higher risk so I will stick with my hybrids. I understand them, I make money out of them and I am comfortable investing in them.

Thanks for detailed response, Bill. I completely understand and respect that you stick with what you feel comfortable with.

Julia said:

Thanks for detailed response, Bill. I completely understand and respect that you stick with what you feel comfortable with.

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Hi Julia, today is a classic example of why I prefer hybrids, convertible notes and floating rate notes.

The market is taking a dive, the XJO down about 1% and tech stocks down 2.4%. On the other hand my hybrids have barely moved and some have even gone up. It provides me a nice stable portfolio with decent income and I can sleep easy at night, cheers.

agree with you, they should be part of most of portfolios

Bill M said:

Hi Julia, today is a classic example of why I prefer hybrids, convertible notes and floating rate notes.

The market is taking a dive, the XJO down about 1% and tech stocks down 2.4%. On the other hand my hybrids have barely moved and some have even gone up. It provides me a nice stable portfolio with decent income and I can sleep easy at night, cheers.

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As I've already agreed, we'll all do what suits us.
I like a large amount in cash - for the 'sleep factor' you mention and find simple trend following a fairly profitable approach to shares. BOQ has just announced a 14% increase on the already very healthy dividend and has offered a decent capital gain. Ditto most of the other banks for yield and imo security.

A good article on hybrid, particularly the latest offerings.

http://www.sharecafe.com.au/ii.asp?a=AV&ai=31933

Let’s see how this might work with the new issue of Commonwealth Bank PERLS VII Capital Notes. They offer a gross yield of 2.8% above the bank bill rate, currently about 2.6%, giving 5.4% in all. But if you were dead set on that yield (and bear in mind that we think chasing yield is generally a bad way to pick investments) then you could match it almost exactly with a portfolio of 50% cash on deposit with CBA (at 3%) and 50% in CBA shares (with a 7.8% grossed up dividend yield).

With this portfolio you’d be getting the same yield, but if everything travels along smoothly, then half your money should enjoy some growth in the income (and probably the capital over the long term) from the shares; and if everything goes to pot half your money will be safe (assuming it’s below the Government’s deposit guarantee).

Contrast this with the hybrid, which gives you the worst of both worlds by limiting your return when things are going well and lumping you in the same boat as equity investors if it all falls apart.

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Everyone is entitled to their opinions.

I think Hybrids are but one more option.

Interesting exercise for you;
/Comsec/CBA/Charts/5year/Compare/CBAPA.
From 9 October 2009 to May 2010, neither outperformed the other.
From May 2010 to consistently through July 2012, the Hybrid outperformed CBA.
From July 2012, CBA has consistently outperformed.

Now try MQG v MBLHB.
The Hybrid is up about 12%, the Ordinary is down about 1%.
At the close of every single day over the last 5 years, the Hybrid has outperformed the Ordinary.

ANZPA outperformed ANZ for approximately half the time over the last 5 years (less clear cut, as ANZPA are only about 4.6 years old, but.

KBLGA v KBL? KBLGA has significantly outperformed since inception.

WOW v WOWHC? Same performance over last 12 months, WOWHC significantly outperformed over the last 6 months.

That article seems to consider two scenarios as possible.
1. Strong growth in equities, meaning your equity investment is safe & your dividend yield isn't too far behind your interest yield.
2. The ordinary shares, and hybrid instruments, are useless.

It completely fails to ignore an approximately stagnant market, or one that is experiencing modest to moderate declines in value. Here, a safe hybrid is much less likely to lose as much value as the ordinary shares - which means capital is preserved.... which is the "cost" of holding the equity instrument, and the reason as to why your expected return is lower.

Having said all that, why I got interested in hybrids originally was because i think some of them have, at times, been incorrectly valued ---> possibly due to being misunderstood / not as well researched / not having mandates to invest in them / too small for fund managers to bother investing in / etc

The regulation on hybrids has changed and you will see issues for the last year or so having more conditions which make hybrids take more of a hit in bad times for the company.