Campbell Dawson

Hybrids have been a popular choice for many investors over the last decade, producing returns that have been slightly less than equity markets, but with much lower risk.

Hybrids are typically issued by financial institutions, including the big banks. They are issued at floating rates and are popular with retail investors because they offer higher yields than term deposits.

While retail investors may see them as an alternative to Term Deposits, Hybrids have a number of equity-like characteristics: distributions are discretionary; they are perpetual rather than having a fixed maturity and they are called at the discretion of the issuer; and they can be converted into equity by the issuer or regulator if certain trigger events occur, notes specialist alternatives research firm Evergreen Ratings.

Evergreen Ratings recently looked at the Hybrids sector and assigned a “Satisfactory” rating to Elstree Investment Management’s Hybrid exchange traded product, the Elstree Hybrid Fund (Chi-X: EHF1).

Evergreen says the Fund is a welcome opportunity for Australian investors to access a well-considered, carefully crafted portfolio of equity hybrids, while enjoying the yield experience of this market segment.

Evergreen Ratings Founder Angela Ashton says: “We believe that hybrid portfolios require ongoing active management because hybrids come in many flavours of debt, equity and embedded options.

“As hybrids are sold into the market, retail investors tend to sell older hybrids (where some of the optionality creates additional uncertainty) in order to buy the newer issues. The result is that the market can oversell, creating opportunities for informed investors.”

The Fund’s aim is to deliver a return greater than short-term interest rates by creating a portfolio of hybrid securities. The Fund was quoted on Chi-X Australia in April this year.

Elstree’s investment case is that the equity hybrid market is inefficient, due to the large number of retail participants and the complexity of each hybrid issue. This inefficiency creates opportunity for an investment manager.

Evergreen says Elstree has a well-credentialed investment team and its investment philosophy, strategy, process and risk management are all tried and tested.

Elstree Hybrid Management Director, Campbell Dawson, says: “With record low interest rates and global instability in the equity markets, investors are crying out for investment options that outperform cash but with less risk than equity markets. An actively managed hybrids portfolio has the potential to fit within that category.”

Mr Dawson adds: “We believe the hybrid market offers opportunities for active investors as it is inherently inefficient. It is dominated by retail investors who have a limited understanding of bank and insurer capital issues, and who under and overreact to issuer specific risks and equity market movements.  We construct portfolios which seek to benefit from market opportunities and inefficiencies and pass these returns on to our investors.”

Elstree uses a bottom-up research process to analyse each hybrid security and ranks each hybrid on a risk-adjusted basis. Weightings are based on the issuer’s credit quality, the security’s liquidity and its price relative to Elstree’s valuation.

The Fund is designed to allow retail investors to access the same successful and long-term investment strategy as Elstree’s actively managed unlisted wholesale fund, the Elstree Enhanced Income Fund (minimum investment $500,000) which has produced an average return of more than 7 percent a year over the past 10 years.

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