Investment Desk Bulletin

10 November 2017

Fixed Income: Corporate and Financial Hybrids - keep holding but be aware of risk profiles

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By Fixed Income Team

The last Fixed Income IDB of the year looks at corporate and financial hybrids, two areas of fixed income which have been central to fixed income allocations in client portfolios. While both provide attractive return opportunities, we always remain mindful to use them selectively due to their risk.

Corporate hybrids sit between senior unsecured debt and equity in a company’s capital structure, therefore they can provide an attractive yield pick-up versus senior debt. Hybrid fixed income instruments are typically issued by large, well run companies and usual have very long final maturities with sub-10 year calls. Credit ratings agencies view them as partly debt and equity. However, the subordinate nature of hybrids comes with additional risks and should not therefore dominate a portfolios Investment Grade exposure.

Financial Hybrids (CoCo’s and Prefs) have been covered in previous IDB presentations and continue to be a favoured area of fixed income investment. Recent results show banks continue to raise their capital base and deleverage their balance sheets. In the US, rising interest rates will boost the net interest income of US Banks, while in Europe, banks have built up significant capital cushions to AT1 triggers.

Despite these favourable developments, we should always remain risk aware particularly with European AT1s. CoCos have performed well and still offer value, but they are a high risk asset so it important to diversify holdings and not to over allocate to the sector.