Hybrids are products that combine the characteristics of shares and fixed interest products..
Hybrid securities are “higher yielding” investments, generally paying regular income to investors a couple of basis points above the bank bill rate. Such investments are popular with retirees seeking higher yields than they’d normally receive from a cash account.
As with most investments, riskier hybrids pay a higher interest payment (otherwise called a coupon or preferred dividend) to compensate investors for the added risk.
When buying a hybrid security you are typically lending money to a bank, insurance company or large corporation, known as the issuer. In return for the loan, the issuer pays a given interest rate (called the coupon) for the life of the security, repaying the principal at maturity (more on this later).
As the name suggests, hybrid securities are a mix between a debt and equity instrument. Before changes to the International Accounting Standards, most hybrid securities issued were reset preference shares (RPS).
RPSs act like traditional bonds to begin with – paying investors a fixed or floating interest rate (often franked) – but at maturity, or the reset date, can be converted to ordinary shares, cashed in, or rolled over into a new security.
This means that investors in hybrids get it both ways; they receive regular coupons for a set period (usually five years), but also receive the equity twist. In the event of bankruptcy, investors in hybrids rank after bondholders but before shareholders in the carve-up of the company’s assets.
All things considered, perpetual step-ups are not as attractive as the old reset preference share. Investors in the new step-ups no longer retain the right to convert their securities to shares, or redeem them for cash. Instead, this right will lie at the feet of the issuer. Basically, the step-up clause means that, in the event that the securities are not converted or redeemed for cash, interest payments are increased (stepped-up) after a specific date. Steps-ups are regarded as marginally inferior to the old reset preference shares since investors are no longer guaranteed the right to cash out at maturity in order to receive their money back.
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