Chris Joye, Co-CIO at Coolabah Capital Institutional Investments and contributing editor with the Australian Financial Review, provides an update on the current hybrids market and the opportunities available for Australian investors looking to access the unique risk and return features of this asset class.
Netwealth portfolio construction series - Hybrids: opportunities, challenges and the state of play for Australian investors
1. Hybrids:
Opportunities, challenges and
the state of play for Australian investors
Presented by
Chris Joye
Co-CIO & Portfolio Manager
Coolabah Capital Institutional Investments
11 September 2018
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Housekeeping
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This webinar and information has been prepared and issued by Netwealth Investments Limited (Netwealth), ABN 85 090 569 109,
AFSL 230975. It contains factual information and general financial product advice only and has been prepared without taking into
account the objectives, financial situation or needs of any individual. The information provided is not intended to be a substitute for
professional financial product advice and you should determine its appropriateness having regard to you or your client’s particular
circumstances. The relevant disclosure document should be obtained from Netwealth and considered before deciding whether to
acquire, dispose of, or to continue to hold, an investment in any Netwealth product.
While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person,
including Netwealth, or any other member of the Netwealth group of companies, accepts responsibility for any loss suffered by any
person arising from reliance on this information.
Disclaimer
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Chris Joye
Co-CIO & Portfolio Manager
Coolabah Capital Institutional Investments
Meet today’s speaker
5. The information contained in this document is general information only and does not constitute personal financial advice. It does not take
into account any person’s financial objectives, situation or needs. It has been prepared by BetaShares Capital Limited (ABN 78 139 566 868,
Australian Financial Services Licence No. 341181) (“BetaShares”). The information is provided for information purposes only and is not a
recommendation to make any investment or adopt any investment strategy. BetaShares assumes no responsibilities for errors, inaccuracies
or omissions in this document. Past performance is not indicative of future performance. Investments in BetaShares Funds are subject to
investment risk and investors may not get back the full amount originally invested. Any person wishing to invest in BetaShares Funds should
obtain a copy of the relevant PDS from www.betashares.com.au and obtain financial advice in light of their individual circumstances.
The BetaShares Active Australian Hybrids Fund (managed fund) is not sponsored, promoted, sold or supported in any other manner by
Solactive AG nor does Solactive AG offer any express or implicit guarantee or assurance either with regard to the results of using the
Solactive Australian Hybrid Securities Index at any time or in any other respect. The Index is calculated and published by Solactive AG.
Neither publication of the Index by Solactive AG nor the licensing of the Index for the purpose of use in connection with the Fund constitutes
a recommendation by Solactive AG to invest capital in the Fund nor does it in any way represent an assurance or opinion of Solactive AG
with regard to any investment in the Fund.
Important Information
Confidential – may not be distributed without the consent of BetaShares Capital 5
6. The investment characteristics of hybrids
The current valuation environment for hybrids: overheated or a
buying opportunity?
An introduction to BetaShares Active Australian Hybrids Fund
(managed fund)
Agenda
6Confidential – may not be distributed without the consent of BetaShares Capital
7. The investment characteristics of hybrids
The current valuation environment for hybrids: overheated or a
buying opportunity?
An introduction to BetaShares Active Australian Hybrids Fund
(managed fund)
Agenda
7Confidential – may not be distributed without the consent of BetaShares Capital
8. What are hybrids?
Hybrid securities combine debt and equity characteristics
Equity like characteristics:
Perpetual instruments
Issuer may suspend distributions
(or not make them) and/or delay
redemption
In some cases may be converted
into equity
Debt like characteristics:
Rank ahead of equity in capital
structure
Pay a regular and defined margin
above bank bill rate (usually
floating)
Fixed date for optional repayment
and conversion to shares
8Confidential – may not be distributed without the consent of BetaShares Capital
9. 9
Hybrids offer attractive level of income vs. cash
and bonds
1.5%
2.2%
3.0%
4.9%
4.0%
1.7%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
RBA Cash High Interest
Cash ETF
(ASX: AAA)
Senior Bank
FRN Index
Listed
Subortinated
FRNs
Bank Hybrids
Running Yield across Security Types: As at 30 June 2018 (% p.a.)
5.7%
Franking
Credits
Cash Yield
Source: Bloomberg. Yield for AAA is before fees. Senior bank FRNs represented by Solactive Australian Bank Senior Floating Rate Bond Index. Subordinated Bank FRNs
represented by ASX listed securities from Solactive Australian Hybrid Securities Index. Bank Hybrids represented by ASX listed AT1 Bank Hybrids from Solactive Australian
Hybrid Securities Index.
Yields are variable and may be lower at time of investment.
Listed
Subordinated
FRNs
Confidential – may not be distributed without the consent of BetaShares Capital
10. Overall hybrids have low volatility, but can
experience declines in risk-on events
-60%
-50%
-40%
-30%
-20%
-10%
0%
Mar-07 Mar-09 Mar-11 Mar-13 Mar-15 Mar-17
Australian hybrids
Australian major bank stocks
Australian corporate fixed-rate bonds
Australian bank floating rate bonds
Confidential – may not be distributed without the consent of BetaShares Capital
Annualised Volatility (%)
5.9%
18.7%
2.1%
0.9%
10
Source: Bloomberg. Investment Exposure: Solactive Australian Hybrid Securities Index, S&P/ASX 200 Banks Index; Bloomberg AusBond Corporate Bond
Index; Solactive Australian Bank Senior Floating Rate Bond Index (QPON ETF's Index). Past performance is not an indicator of future performance. You cannot
invest directly in an index. * For Australian Hybrids data, a spliced index series used incorporating Evans & Partners All Bonds & Hybrids ASX Index prior to
February 2012, Solactive Australian Hybrid Securities Index from February 2012.
11. 11
Hybrids offer strong diversification benefits to
portfolios
Daily return correlation as at 30 June 2018
Note: Australian Hybrids data used is the Solactive Australian Hybrid Securities Index, Floating Rate Bond Data is Solactive Senior Floating Rate Bond Index,
Australian shares is the S&P/ASX 200 Index, Australian Fixed Rate Bonds is the Bloomberg Composite Bond Index. Source: Bloomberg. Past performance is not an
indicator of future performance.
Australian Hybrids
Australian Bank
Floating Rate
Bonds
Australian
Shares
Australian Fixed Rate
Bonds
Australian Hybrids
1.000 0.124 0.331 -0.092
Australian Bank Floating Rate
Bonds
0.124 1.000 0.123 -0.033
Australian Shares
0.331 0.123 1.000 -0.224
Australian Fixed Rate Bonds
-0.092 -0.033 -0.224 1.000
Confidential – may not be distributed without the consent of BetaShares Capital
12. Hybrids – can’t just set and forget…
Major Bank Hybrid Trading Margins – lost opportunities if you are a static investor
0
100
200
300
400
500
600
700
2013 2014 2015 2016 2017
Major Bank 5 Year Hybrid Spread Major Bank 2 Year Hybrid Spread
Source: Coolabah Capital Investments. Past performance is not an indicator of future performance.
12Confidential – may not be distributed without the consent of BetaShares Capital
13. Not all hybrids are created equal…
Source: Morningstar
13Confidential – may not be distributed without the consent of BetaShares Capital
14. Hybrids market is relatively illiquid –
professional investors may have an advantage
Bid-Offer Spread of Commonwealth Bank Equity and Hybrids
Confidential – may not be distributed without the consent of BetaShares Capital 14
Source: Morningstar
15. Agenda
The investment characteristics of hybrids
The current valuation environment for hybrids: overheated or a
buying opportunity?
An introduction to BetaShares Active Australian Hybrids Fund
(managed fund)
15Confidential – may not be distributed without the consent of BetaShares Capital
16. Current valuations for hybrids are attractive
with recent blow-out in spreads
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
Jun-04 Jun-06 Jun-08 Jun-10 Jun-12 Jun-14 Jun-16
AverageMajorBankAT1TradingMargin(>1Year)
HBRD’s mandate keeps valuations front and centre
Confidential – may not be distributed without the consent of BetaShares Capital 16
Source: Bond Adviser. Past performance is not an indicator of future performance.
17. Hybrids attractive on both cash yield basis and
including franking
Confidential – may not be distributed without the consent of BetaShares Capital
2.0%
4.1%
4.0%
3.7% 3.5%
4.0%
4.4% 4.2% 4.0%
5.4%
4.4% 4.4% 4.6%
5.7% 5.5%
7.0%
6.3%
2.0%
5.4% 5.7% 5.5% 5.7% 5.6%
5.9% 6.0% 6.1%
6.5% 6.3% 6.2% 6.3%
8.2%
7.8%
10.0%
9.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
WBC90dayTD
ASX200Index
ANZPE
CBAPF
NABPD
WBCPE
CBAPD
ANZPF
ANZPG
ANZPG
ANZPH
CBAPG
WBCPH
CBAshares
ANZshares
NABshares
WBCshares
Returns Across the Capital Structure as at 12 July 2018
Franked Yield Cash Yield
17
Source: Coolabah Capital Investments.
18. Navigating Hybrids
The hybrids market is relatively inefficient and thus prone to regular over and under valuation – some
investors may not have the ability to accurately price these securities
Most investors’ hybrid holdings tend to be relatively passive creating the potential for risks to capital if
securities become overvalued or during “risk-on” events
The issuance terms of hybrid securities are complex and can differ greatly from security to security
which, along with the relatively low ranking of hybrids in the capital structure, makes understanding the
idiosyncrasies of each security all the more important
Holdings of hybrids in directly held portfolios tend to be relatively concentrated (often 3-5 individual
securities) creating potential for security and issuer risk
The passive nature of many investors’ hybrid holdings has led to a relatively illiquid listed market in
hybrid securities
18Confidential – may not be distributed without the consent of BetaShares Capital
19. Agenda
The investment characteristics of hybrids
The current valuation environment for hybrids: overheated or a
buying opportunity?
An introduction to BetaShares Active Australian Hybrids Fund
(managed fund)
19Confidential – may not be distributed without the consent of BetaShares Capital
20. A potential solution?
We believe many of the complexities of holding hybrids can be largely addressed via the use of an
actively managed hybrids exposure run by an experienced professional manager:
A professional manager may have valuation models allowing them to detect and potentially profit from mispricing in the relatively
inefficient and retail focussed hybrid market
A professional manager may potentially have a greater ability to detect overvalued securities and mitigate risks to capital than an
investor without sophisticated valuation models
A professional manager may have a greater understanding of the issuance terms and complexities of individual securities to potentially
identify and mitigate risks
A professional manager will likely hold a broader and more diversified portfolio of hybrid securities (~20-50 in the case of HBRD) and
may therefore reduce concentration risk for many investors
A professional manager may have access to deeper liquidity
Using a professional manager may assist in alpha generation, risk mitigation, improving diversification and building scalability in
portfolios
20Confidential – may not be distributed without the consent of BetaShares Capital
21. Product Name: BetaShares Active Australian Hybrids Fund (managed fund)
Investment Objective The Fund provides investors with a convenient way to access attractive income returns, including franking credits, from an actively managed, diversified portfolio
of hybrid securities. As the Fund is overseen by a professional investment manager it actively seeks to reduce the volatility and downside risk that may otherwise
be experienced by direct holders of hybrids.
Confidential – may not be distributed without the consent of BetaShares Capital 21
ASX: HBRD
Key Information
ASX Code HBRD
Bloomberg Code HBRD AU
IRESS Code HBRD.AXW
Asset backing
Australian Hybrids,
Bonds & Cash
Management Fee 0.45% p.a.
Expense recoveries
Capped at 0.10%
p.a.
Performance Fee
15.5%
outperformance to
Solactive Hybrids
Index
Inception Date 13 November 2017
Sector Allocation (%)
As at 31 August 2018
Top 10 Index Constituents
As at 31 August 2018
Company Weighting
ANZPE
ANZPF
ANZPG
CBAPD
CBAPE
CBAPF
CBAPG
NABPC
NABPD
WBCPG
BetaShares Active Australian Hybrids Fund
(managed fund) (ASX: HBRD)
22. HBRD targets:
Returns after fees that are greater than Australian Hybrids Index(1)
Post-fee returns > RBA cash rate + 2.5% pa over medium term
Post-fee, franked running yield generally similar to Australian Hybrids Index(1)
Post-fee volatility of 3-4% p.a.
Minimal interest rate duration – floating rate exposure only
Ability to go 100% cash/bonds if hybrids materially overvalued
Ability to invest up/down capital structure depending on relative value
Ability to hold following securities:
- Cash
- Bonds
- Subordinated debt
- Australian Hybrids
Investment Strategy for HBRD (I)
(1) Solactive Australian Hybrid Securities Index
22Confidential – may not be distributed without the consent of BetaShares Capital
23. Fund adopts a hub-spoke strategy
Core holdings are ASX hybrids during
normal conditions to meet post-fee yield
targets
Augmented by cash, bonds and sub-debt
Expecting to hold 20-50 positions across
cash, bonds, hybrids
Actual portfolio weights will depend on:
• Relative value opportunities
• Bottom-up analysis on outright
valuation fundamentals
• Risk-aversion
Investment Strategy for HBRD (II)
ASX
Hybrids
Cash
Sub-
Debt
Senior
Bonds
23Confidential – may not be distributed without the consent of BetaShares Capital
24. Deliberate flexibility to range
up/down corporate capital
structure depending on
assessed opportunities
Cannot hold ordinary
shares/equities
Approach assists in preserving
capital when core hybrid
holdings become overvalued
Risk/return targets motivate
alpha generation/excess returns
subject to not increasing
volatility beyond ASX hybrid
market
Investment Strategy for HBRD (III)
• Senior secured covered bonds (Debt)
• Cash deposits (Debt)
• Senior unsecured bonds (Debt)
• Subordinated bonds
• Hybrids
24Confidential – may not be distributed without the consent of BetaShares Capital
25. About CCI
HBRD is actively managed by Coolabah Capital Institutional Investments (“CCI”), a leading independent
Australian active-fixed income specialist
CCI is a specialist “active credit” investor with ~$2.5bn in FUM, and one Australia’s largest fixed-income boutiques
• Established 2011, 75% owned by investment team, 25% owned by large Australian family office
CCI has a strong record of alpha generation
• As at June 2018, one of top Australian cash plus/short-term fixed interest portfolios past ~6yrs
• Seeks to deliver “true alpha” not 1/ duration beta, 2/ credit beta, or 3/ illiquidity beta
• Seeks to identify asset mispricings using rigorous quantitative valuation capabilities
• Investment Approach: when mispricings converge with fair value, realise capital gains + income
Leading credit research & quant fixed-income capability
• 10-20x different quant valuation models
• Investment team comprises 4x portfolio managers and 6x analysts
• 2x senior portfolio managers
• 2x portfolio managers/quant analysts,
• 3x credit analysts,
• 2x data scientists and 1x market technical analyst
• Chaired by Melda Donnelly (ex CEO QIC) with Independent Director Bob Henricks (ex Chair Energy Super)
Source: Lonsec
25Confidential – may not be distributed without the consent of BetaShares Capital
26. Historic Performance vs Hybrids
Source: CCI. Past performance is not an indicator of future performance.
SMAC & SMHI Bond Returns vs FRN Index, Composite Bond Index, ASX Hybrids Index
26Confidential – may not be distributed without the consent of BetaShares Capital
27. Historic Performance vs Hybrids
Source: Coolabah Capital Investments (conservatively assumes cash earns on av. RBA cash + 90bps). Past performance is not an indicator of future performance.
SMAC Implied
FRN Returns
Spliced
SMAC/SMHI
Implied FRN
Returns
RBA Cash
Rate
AusBond
FRN Index
AusBond
Composite
Bond Index
ASX Hybrids
Annual Std Deviation 1.49% 1.48% NA 0.54% 2.69% 2.85%
Compound Annual Return 6.87% 7.02% 2.29% 3.91% 4.69% 5.32%
Sharpe Ratio 3.08 3.19 na 3.02 0.89 1.06
February 2012 to May 2018 Pre-Fee (Gross) Value-Weighted Returns
27Confidential – may not be distributed without the consent of BetaShares Capital
28. Trade-by-Trade Analysis: > 98% Win Ratio
Source: CCI. Past performance is not an indicator of future performance.
All Realised Security Sales Since Inception Applying Last-in, First-out (LIFO) Method:
Bonds/Hybrids Only, Excludes Cash (After Brokerage But Before Fund Fees)
28Confidential – may not be distributed without the consent of BetaShares Capital
29. HBRD has outperformed the ASX hybrids
market after all fees and transaction costs since inception
HBRD vs Index Since Inception (November 2017 – June 2018) – After All Fees, Charges, Transaction Costs;
before franking credits
Confidential – may not be distributed without the consent of BetaShares Capital
-1.00%
-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18
Solactive Australian Hybrid Securities Index (Net)HBRD
Source: Betashares, Solactive. Past performance is not an indicator of future performance.
29
30. Re-cap: Why Hybrids Market Is Well Suited For Active
Management
We believe the hybrids market is well suited to active management for the following reasons:
1. Potential for alpha generation in a relatively inefficient market
2. Potential to mitigate :
Risks to capital arising from exposure to overvalued securities
Risks to capital as a result of issuance term complexity
Risks to capital from default thanks to detailed modelling
Risks to capital from concentrated holdings by adding significant diversification
3. Potential to access a broader liquidity base than many investors may see in ASX listed turnover
30Confidential – may not be distributed without the consent of BetaShares Capital
31. Investment risk: Investment returns are uncertain and will be influenced by the performance of the
markets as a whole and other risks.
Income payments are variable. If interest rates fall, HBRD’s income payments can be expected to fall.
Hybrids are, by their nature, predominately issued by banks, creating sector concentration risk.
HBRD is exposed to the credit risk of issuers. Hybrids rank behind all-debt and deposit holders in the
event of issuer default and can be converted into equity or written-of by regulator
The issuance terms of hybrid securities are complex and can differ greatly from security to security
See PDS for more information about risks.
Things to keep in mind
31Confidential – may not be distributed without the consent of BetaShares Capital
33. | netwealth33
This webinar and information has been prepared and issued by Netwealth Investments Limited (Netwealth), ABN 85 090 569 109,
AFSL 230975. It contains factual information and general financial product advice only and has been prepared without taking into
account the objectives, financial situation or needs of any individual. The information provided is not intended to be a substitute for
professional financial product advice and you should determine its appropriateness having regard to you or your client’s particular
circumstances. The relevant disclosure document should be obtained from Netwealth and considered before deciding whether to
acquire, dispose of, or to continue to hold, an investment in any Netwealth product.
While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person,
including Netwealth, or any other member of the Netwealth group of companies, accepts responsibility for any loss suffered by any
person arising from reliance on this information.
Disclaimer
Thank you
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