Q&A: Using hybrids in your portfolio

The InvestSMART Hybrid Income Portfolio invests in a selection of income securities such as preference shares and convertible notes. InvestSMART's Head of Funds Management, Alastair Davidson is not just the Portfolio Manager but also an investor via his SMSF. If you have further questions please leave comments below and we'll be happy to answer them for you.

What role do hybrids play in my portfolio as a retiree? What asset class do they fall into and approximately what percentage of that asset class should I apportion to hybrids?

Hybrids are preference shares that pay a floating rate of return each quarter which is usually franked. For retirees, this is a good source of regular income, similar to, though riskier than, a term deposit.

Hybrids are typically held as defensive assets, though there is some equity risk.  These would normally be included as part of your bond or fixed interest allocation, and should be less than 50% of that allocation.

What relationship do rising interest rates have on hybrids? And how has our portfolio faired in this environment?

Rising interest rates are not usually good news for bond and fixed interest portfolios as capital values tend to fall. However, as hybrids have distributions based on a fixed margin above the cash rate, as the cash rate increases then the distributions increase

Will you be restructuring the portfolio to have more floating rate hybrids instead of fixed?

The portfolio currently only has floating rate hybrids which have been issued by the major banks

Why is the minimum investment amount $25,000?

There are currently 10 securities in the portfolio which provides a spread of maturities and different corporate exposures, and it is unlikely that the portfolio will hold fewer. As there is a minimum brokerage charge of $4.40 (inc GST), the brokerage costs for buying the 10 securities for investments less than $25,000 would be high and would impact on returns.

If I can get around 3.65% p.a. on a 12-month term deposit, why would I invest in hybrids which are riskier?

The yield on the hybrid portfolio is currently approximately 3.9% excluding franking credits. The franking credits add an additional 1.5% yield, making a total of 5.4%. Hybrids are riskier, and there are brokerage costs involved in buying and selling.

Will I ever receive shares on the conversion date? What happens there?

When a hybrid reaches it’s first “call” date, the issuing bank has the choice to pay the investor in shares or cash equivalent to the issue price of the hybrid (usually $100). To date all the major bank hybrid issuers have redeemed their hybrids for cash. If an issuer decided to issue shares, you would receive enough shares to give you the same cash value as the issue price.

Do I get franking credits from hybrids?

All the hybrids in the InvestSMART pay franking credits on each distribution

How do I claim my franking credits?

When you lodge your tax return, you will receive a credit for the tax already paid on the hybrid distribution. Depending on your tax situation you may get a tax refund

What is the difference between a bond and hybrid?

A bond is issued at a note by a corporate or government and is redeemed on a fixed date in the future. Bonds usually pay a fixed rate of interest semi-annually.

Hybrids are preference shares and rank below bonds in the event of a liquidation of the issuer, pay dividends which can be franked and usually have no maturity date. Investors are relying in the issuer to “call” (redeem) the issue to be repaid, or will have to sell on the ASX to get their investment back.

The InvestSMART Hybrid Income Portfolio is part of InvestSMART's capped fee range. Click here for more information.