Interest rate securities and bonds
Investors looking to receive a steady stream of income often only consider bank term deposits. However, bonds (or Interest Rate Securities a type of ‘debt security’) traded on ASX can present an attractive alternative.
Bonds generally provide greater certainty on their income stream and return of capital, unlike equities. The regular interest income and principal repayments of bonds at maturity can provide a greater level of security for retirees or others (SMSFs). Learn more
There are three types of bonds quoted on ASX. They can be broadly classified into the type of interest they pay (fixed, floating or indexed), and can be split into categories based on the issuer (government or corporate).
ASX has produced a handy booklet – Understanding Bonds that you should read before investing in this asset class.
Hybrid securities
Hybrid securities traded on ASX can present an attractive alternative for investors who are looking to receive a steady stream of income. Further, in comparison to Bonds they generally pay a higher interest payment to compensate the investor for the added risk.
A hybrid security is one that combines elements of debt securities (fixed interest) and equity securities (shares). Hybrid securities, like debt securities, allow banks and companies to borrow money from investors with a promise to pay a rate of return (fixed or floating) until a certain date. They can also have equity-like characteristics and provide a higher rate of return than regular debt securities.
There are three broad categories of hybrid securities traded on ASX:
Convertible/converting debt securities
A convertible debt security is one that gives either the investor or the issuer the option to convert it into another type of security at a specified date in the future
Preference shares
Unlike ordinary shares, which pay a variable dividend rate as determined by the directors of the company, preference shares usually carry a specified dividend rate.
Capital notes
Capital notes are debt securities that have equity-like features, including:
Knock-out debt securities
Subordinated debt securities
Perpetual debt securities
The benefits
Receive a steady and defined income stream for a pre-determined period
Improve the return on your capital – the income from hybrid securities is typically higher than interest paid on simple bonds reflecting their higher risk
Diversify the risk of your overall portfolio
Profit from anticipated movements in interest rates or equity prices.
Some common risks
Trigger events – returns from Hybrids are often dependant on whether certain events do not occur typically there are a wide ranges of events or conditions imbedded into these securities types that can be complex, difficult to predict and outside the control of issuing company
Liquidity risk – Hybrids are often less liquid than shares in the company that issued them. With fewer buyers and sellers bid-ask spreads or large price movements (especially to the downside) are more likely during times of crisis
Subordinated ranking – generally Hybrids are ‘unsecured’ or not backed by a security interest over the company’s assets. In the event the issuer becomes insolvent, the investor holding the hybrid will rank behind other creditors such as senior bond holders and be amongst the last to get their money back.
