Given the nature of hybrid securities it might be pertinent to start with a risk warning. Hybrid securities are complex products and even experienced investors sometimes struggle to understand the risks involved when investing. Therefore, if you do not fully understand how they work and the risks involved you should not invest.
Hybrid securities pay a predictable (fixed or floating) rate of return or dividend (much like bonds) until a certain date, at which point the issuer has a number of options including converting the security into ordinary shares. Although at first glance, these hybrids might seem like a bond, the risk attached to them is more like that of shares.
You should not judge a security by its name. However, the name of the security might give you an indication as to whether the security is a hybrid or not. For example, if the name includes any of the following terms: “Non-Cumulative”, “Callable”, “Preferred Securities” “Enhanced Capital Advantaged Preferred Securities” and/or “preference shares” BE CAREFUL. You might be acquiring a security whose level of risk is much more than you anticipate. In addition, check when these securities mature – some hybrid securities may mature 50 years after their initial date of issue!
There are several complex and risky aspects to such products:
Subordinated ranking – Hybrid securities are generally unsecured, meaning that repayment of capital is not collateralised by a security on specific assets of the issuer in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. If the issuer is placed into liquidation, a liquidation payment (if any) would be made after all the other creditors (i.e. a person or company to whom the issuer owes money) and debt of the company have been paid.
Extremely long timeframes – It is common for hybrids to have investment terms lasting several decades (10, 20 years or even longer). That is why such securities may be called “perpetual” securities. A perpetual security exposes the investor to a higher risk as there is no fixed date when the capital invested will be returned.
Volatile Market price – As with many investments, the market price of hybrid securities listed on a stock exchange may fall below the price that you would have originally paid, especially if the company suspends or defers interest payments, or if its performance or prospects decline. Hybrid securities are generally characterized by high fluctuations in price.
Early termination by issuer – Some hybrid offers allow the issuer to terminate or 'buy back' the investment early but do not give that same right to investors. This is usually at the discretion of the issuer.
Interest payments deferral – Some offers allow the company to suspend dividend payments for a number of years. If the security offers a “Non-Cumulative” dividend and the issuer suspends dividend payments for a particular time period, you will then lose any right to claim that unpaid dividend. This suspension of dividend can normally be extended at the discretion of the issuer.
If you don't understand how the investment works and have not been given sufficient documentation which you can easily understand, don't invest!
You may also be interested in understanding the risks of complex investment products. Click here for more information. Last updated: Sep 07, 2016