Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 454

The forgotten asset class set to outperform in 2022

Against a backdrop of economic and geopolitical uncertainty, rising inflation and expectations of a rate hike, Australian investors are searching for investments that can benefit from these evolving market conditions.

With credit spreads at attractive levels, now might be the opportune time to have exposure to hybrids and credit. With minimal returns on cash continuing to underpin strong demand for hybrid securities, we anticipate demand for yield to remain robust throughout 2022, resulting in strong returns over the year for this asset class.

The upside of rising interest rates

Rising inflation, above average GDP growth and the unwinding of quantitative easing (QE) in 2022 has seen financial markets reprice interest rate expectations.

The rising rate environment will push the outright return on hybrid securities higher, without having a material impact on spreads given the strong economic backdrop. Given most hybrids are floating rate, investors will benefit via higher income from these rising short-term rates.

Strong balance sheets you can bank on

Australian banks are the largest issuers of hybrids domestically and their balance sheets are in fantastic shape, with capital ratios at historical high levels. COVID-19 provided Australian banks with access to cheap funding via the Term Funding Facility (TFF), which provided them with a degree of funding certainty and lower funding costs.

Following the withdrawal of the TFF in 2021, new bank issuance is coming to market at attractive credit margins, providing the ideal environment for active credit managers to identify the most positive risk adjusted opportunities.

For instance, bank senior credit margins are significantly off their TFF lows, which is leading to an attractive re-pricing across all bank capital issuance (refer to Chart 1). Overvalued growth sectors are likely to lead an equity market sell off similar to 2000 – 02, but are unlikely to impact credit market returns.

Chart 1: Bank senior credit margins – Well-Off Their TFF 2021 lows

Source: YCM/NAB/BBG –March 18, 2022

Fully protected from higher interest rates with high carry protecting returns

The higher the carry (running yield of an investment), the greater the protection it offers investors from adverse movements in credit margins. The carry for the Yarra Enhanced Income Fund (“EIF”) is currently sitting at ~3.0% above cash.

Based on an average portfolio maturity of ~3 years, we’d need to see an extreme 1.0% move wider in credit margins to wipe-out the carry. However, given the robust economic backdrop in 2022, we expect credit margins to remain relatively stable throughout, adding to floating rate credit’s income generating credentials.

This benign outlook is in contrast to the capital losses currently being observed in traditional fixed income due to the reset in interest rates and real yields. Usually, a rise in real yields will impact the value of everything long interest rate duration, from traditional fixed income to most equities. That’s not the case with floating rate credit, since its short duration offers protection to portfolio valuations from rising interest rates. This is observable in EIF’s outperformance compared to traditional fixed income (Bloomberg Composite Index) since February 2020 (see Chart 2).

Chart 2: Floating rate credit with carry continues to outperform fixed rate with little carry

Source: Yarra Capital Management, Bloomberg. As of March 18, 2022

Making the grade

In a world that seems to be getting riskier by the minute, investment grade hybrids look to be a safe haven for investors. Here’s why:

  • Investment grade hybrids appear to be fairly priced in an environment appearing increasingly more expensive, especially if real yields rise or normalise in a post QE world.
  • Investment grade issuers remain well capitalised, making them more likely to be able to service their interest payments and repay debt.
  • Most Australian investment grade hybrids are floating rate securities, which tend to pay higher yields if prevailing rates go up because they are based on a variable interest rate, rather than fixed. Not only does this mean more income when rates rise, but there is also no loss of capital.

 

Roy Keenan is Co-Head of Australian Fixed Income at Yarra Capital Management.

 

6 Comments
Alan B
May 02, 2022

Domestic and overseas shares and ETFs that focus on fixed rate securities are all falling in price, some by >20% since 2021, meaning capital loss. Hybrids and floating note bonds are all priced up above their issue price meaning the yield is low. I'm attracted to floating notes, just not seeing value opportunities.

Michael O'Rourke
April 22, 2022

It is fairly clear that ASIC is more focused on the uninformed consumer rather than the average retail investor, of whom they have very little knowledge. (ATO deals with SMSF's, and ASIC most likely doesn't understand how SMSF's work, as so many public "servants" access the very generous commonwealth super scheme).
The punitive approach adopted by ASIC in recent years to ensure compliance initially "glued up" establishing simple accounts and increased costs with no real benefit to investors. What caused the change on hybrids? What was the rationale? Are they worried there is a risk of systemic failure of our banking system? Surely Austrac know bank hybrids can be purchased on the ASX. Will the next step be that you have to be classified as wholesale to purchase shares which entail even more risk than hybrids?
Another commonwealth entity which seems to lack competence is Austrac. Why isn't their performance being questioned? Wasn't it "common knowledge" that high rollers in casinos might be an issue. Now years afterwards they are enquiring. The bottom line is that Austrac has not developed the fundamental tracking tools themselves but expect others should and happily impose costs on the wide range of investors for no real benefit. Crime is a problem but surely in these days of big data Austrac could do better and be held responsible.

CC
April 13, 2022

Floating rate securities are definitely the way to go in the fixed income part of one's portfolio

William Allan Cross
April 17, 2022

Funny how the minute that hybrids start looking attractive the big end of town influences the regulator to make purchasing new issues almost impossible for the little end of town.

David paine
April 20, 2022

As a part of the "little end of town" I have been totally miffed over the last couple of years with the examples where we have been attacked. This change from late 2021 you mention for hybrid issues is appalling for us.

Alexander Smith
April 21, 2022

It would be interesting to learn of ASIC's reasoning (or lack thereof) in their decision to allow retail investors to pay through the nose for quality hybrids on the secondary market, but block the little guys from participating in new issuances of those same company hybrids without the brokerage charges and price increases for good quality securities.

 

Leave a Comment:

RELATED ARTICLES

The naysayers may be wrong again on the Big Four banks

Why bank hybrids are being priced at a premium

Little to fear from APRA's hybrids review

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.