Key points:

• ASIC will now focus on possible misleading conduct in the sale of hybrids. This includes inappropriate labeling of hybrids and unwarranted comparison of hybrids to different, less risky products e.g. covered bonds or senior debt
• Spruiking the potential higher returns of hybrids and the brand name or reputation of the issuer without balancing that with the risks of the product can also cause investors to be misled
• Investor education about these products is critical. ASIC will explore whether new strategies can be developed to help investors check their understanding of hybrids before investing in them

ASIC today released Report 365 Hybrid securities (REP 365) which discusses recent offers of hybrids in Australia.

There has been more than $18 billion of hybrids issued by banks and corporates since November 2011. There were approximately 75,000 investors in hybrid securities last year, two thirds of whom were self-managed superannuation funds (source: Investment Trends)

ASIC has reviewed the selling methods and sales processes of issuers and brokers. REP 365 discusses the findings of the review in detail.

‘Investor education is critical while those distributing these products need also to do the right thing,’ ASIC Commissioner John Price said.

‘We have responded to the increased issuance and popularity of hybrids by working with issuers and their advisers, as gatekeepers, to help improve prospectus disclosure and ensure selling messages are not misleading.

‘But there is more work to be done and we will investigate any reports of misconduct (e.g., misleading promotion or inappropriate comparisons with other products), crackdown on misleading ads, and consider what names or labels hybrid products are given to ensure they do not confuse investors.’

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Based on a survey of 9,537 Australian investors, the seventh annual edition of the Investment Trends November 2012 Investor Product Needs Report is an in-depth study of the Australian investor population and their demand and usage of a wide range of investment products.

“2012 was another tough year for the Australian investment industry. Investors remained fearful with muted return expectations leading many to remain on the sidelines in cash. That said, there were some bright spots” said Investment Trends Principal Mark Johnston.

 As investors remained cautious, they continued to focus less on capital growth and more on income. This continued change in focus has helped shape the demand for different products, particularly hybrid securities, where investor numbers increased 21% from 2011 levels to 75,000 as at November 2012. Self managed super funds remained the dominant holders of hybrid securities, accounting for two-thirds of the market (by investor numbers).

Over the year to November 2012, the number of active warrant investors rose 34% from 26,000 to 35,000 as the number of warrants on issue increased 28% over the same period, filling a vacuum that had existed for these products for the last few years.

Index funds and exchange traded funds (ETFs) saw growth as investors remained very cost focused.

 UBank has the happiest cash clients
“Providers of cash accounts, term deposits and online savings accounts also did very well over 2012. Of particular note is NAB’s UBank, which had the highest levels of client satisfaction of any cash product provider.

That said, they remain vulnerable in spite of this satisfaction since a large proportion of thers are rate-chasers who are willing to switch providers if a better offer comes along,” said Johnston.

Despite a falling cash rate and the performance of the Australian share market, investors’ cash holdings continued to build up, with a corresponding increase in excess cash – cash that would normally have been invested in other investments/assets.

Green shoots appearing in 2013
“Over the last few years investors continued to hold and accumulate cash (and excess cash). When we ask them what would prompt them to invest this extra cash, increased confidence in the market and economy are the major catalysts cited,” said Johnston.

“Since the end of 2012 though, we have seen a big spike in investor return expectations, which rose from 3%p.a. in September 2012 to 8%p.a. in February 2013, a 20-month high. This rising sentiment is thus a very significant development for the Australian investment industry.”

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While not commenting on individual offers, ASIC Commissioner John Price warned consumers to be wary of these complex products, which can be issued as subordinated notes or convertible preference shares.

‘Despite household name companies and trusted brands being linked to certain offers and promises of ‘high yields’, consumers should be very careful,’ Mr Price said.

‘Some hybrid securities and notes are highly risky investments. Hybrids need to be closely reviewed. Consumers should think hard about whether hybrids are suitable for them , and read and understand the prospectus.

‘If they are still in doubt, they should get some unbiased financial advice before parting with their money.’

Mr Price noted there have been some cases where hybrids had not been paid back when investors expected because the company had a choice about when to redeem those investments.

‘An expectation that at the end of a set period an issuer will definitely redeem the hybrid so that investors get repaid in full is very dangerous.’, Mr Price said

Other risks include:

• Some hybrids have investment terms lasting several decades if they are not redeemed earlier. For example, with a 60-year term, a 40 year-old investing today would need to live to 100 to see their investment mature.
• The price of hybrids can drop below what you originally paid, making it hard to get out of your investment at the price you want.
• Despite the advertised high interest rates, some companies will stop paying interest if their financial position deteriorates.
• Hybrids are generally subordinated. This mean if the bank or company which has issued the securities fails, you have to line up at the back of the queue behind other creditors.

As the appetite for these products grow amid investor unwillingness to depart with their cash unless a product is pitched as ‘safe’, Mr Price reminded issuers their disclosure documents should be clear, concise and effective.

‘They should communicate the key features and risks of these products so retail investors can understand what they are buying,’ Mr Price said.

‘With complex products like these, issuers need to really focus on how information can be best presented to assist investors to make an informed investment decision. In particular, issuers should make sure these products are true to label. For example it may be more appropriate for these products to be called capital notes to reflect the nature and features of the product. Any advertising for these products should also be appropriately balanced.’

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With considerable volatility in equity markets, many investors are looking for alternative investments, including debt and fixed interest securities. However, some of these alternatives need close scrutiny before the decision to invest is made.

ASIC Chairman Greg Medcraft said: ‘Retail investors may be attracted by the interest rates offered by household name companies and trusted brands, but hybrid securities should not be confused with government bonds or ‘vanilla’ corporate debt. In some cases investors are taking on equity-like risks but only receiving bond-like returns.

‘Investors need to understand the conditions of these offers, such as terms and conditions that allow the issuer to exit the deal or suspend interest payments, and long term maturity dates of several decades. We want to ensure consumers are fully informed before they invest,’ Mr Medcraft said. 

Consumer tips
ASIC advises consumers and retail investors who are thinking about investing in a corporate hybrid security to compare offers, read and understand prospectuses, and pay particular attention to the risks.

Most hybrid securities are likely to be sold or recommended to consumers by brokers and financial advisers. ASIC expects these gatekeepers to clearly explain the features and risks of the investments to their clients. Below are five important issues that prospective investors should make sure their broker or adviser explains:

• What are the risks of investing in this hybrid security?
• Will the returns offered adequately compensate me for the investment risks?
• How does the interest rate compare with other investments on a ‘risk adjusted’ basis? Can other less complex, risky or long-term investments provide a similar or better return?
• Will this product help the investor achieve their personal goal and objectives, and does it suit their investment timeframe and risk profile?
• Can investors exit the investment if their circumstances change?

Consumers should always make sure their adviser is licensed to provide financial advice, and get personal advice in writing (a Statement of Advice).

For information about other types of fixed interest investments and to download ASIC’s guide to investing in corporate bonds, visit www.moneysmart.gov.au

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