What banks dont want retail to know

Published in the Australian Banking and Finance Magazine, August 2013 by Marion Williams

Retail investors, desperate for income, have been absorbing the huge amounts of hybrid instruments issued by the banks. 

But retail investors don’t know what the banks and institutional investors know.

Janine Cox, investment analyst at Wealth Within, said they’re being marketed as an income play. 

“These types of investments tend to be taken up by retirees or those looking for income.”

They’re distributed by the private wealth divisions and retail arms of big banks and stockbrokers.

One such broker is Bell Potter which, according to its website, has acted as a co-manager on the biggest listed hybrid and debt securities of the last 12 months with a combined deal value of over $9.2 billion.

It describes listed hybrid and debt securities as a fixed income style of security that has the potential to increase yield albeit with a slightly increased risk than a traditional bank term deposit or government bond.

It’s concerning that the stockbroker lumps together hybrid and debt securities, let alone claims hybrid securities have a “slightly increased risk” than term deposits or government bonds.

Bell Potter goes on to say that hybrids pay a pre-determined distribution, either fixed or floating-rate, at regular intervals, so the investor has a known cash flow.

The Australian Securities and Investments Commission (ASIC) disagrees. It said on its website that “hybrid securities may be unsuitable for you if you need steady returns or capital security.”

Macquarie Investment Management (MIM) has done the analysis to show why.

In a report obtained by AB+F, MIM said that in falling equity markets, the income yield provided by hybrid securities failed to offset the substantial decline in capital values, highlighting the downside correlation of hybrid securities to equities in difficult times.

“This correlation demonstrates that hybrid securities aren’t a substitute for fixed income as the income flows are less certain while the principal value has shown to be volatile, akin to holding equity.”

“Our analysis shows that hybrids perform like debt when equity markets perform well, and perform like equity when equity markets perform poorly.”

In other words, it is a lose/lose situation for investors in hybrids and they would be better off holding equity.

The MIM analysts compared the total return performance for equity, hybrids, subordinated debt and senior debt issued by the four major banks, Macquarie and Suncorp.

MIM’s report is for “adviser and wholesale investor use only – not to be distributed to retail investors.”

It appears that banks are offering hybrid securities with inadequate return to compensate for the risk given professional investors aren’t taking them up. 

Why would they? Institutional investors have access to research and analysis that isn’t offered to retail investors that gives the real story on how hybrid securities perform.

Furthermore, hybrid issuers tend to get credit ratings on their securities for institutional investors, meaning they can see how many notches the hybrid instruments are rated below senior debt, another assessment of risk that again retail investors are denied.