Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 308

What now for SMSFs and hybrids?

Well, that was unexpected. The election delivered a revolt against Labor's franking credit policy. Prior to the election, we thought there would be little influence on the hybrid market because there was sufficient demand outside the affected investors to soak up the next few years of supply. If and when SMSFs did react to the policy, their biggest issue was their franked equity portfolio. Equity allocations are much larger in most SMSF portfolios.

At time of writing, the bank component of the Elstree Hybrid Index is up around 0.5% compared to the 9% increase in the S&P/ASX200 Bank Index. The hybrid return is only just in the top 5% of two-day returns over the last 10 years. Given that the election outcome was clearly unexpected, it indicates there are not yet a lot of pension SMSF investors returning to the market.

Ignore us and think long term

When it comes to hybrids, investors should consider our short-term guesses as next to useless for the simple reason that we believe hybrids should be a component of most income portfolio. Investors should be insensitive to 1%-2% price movements because of the favourable characteristics hybrids bring to portfolios:

  • Cash rates are going to 1% and term deposit rates will be around 1.5% in a few months.
  • The hybrid return of cash rates +3% or so is close to equity market returns over the long term and equivalent to income returns from high yield bonds or loan funds.
  • Hybrids are not volatile except in big equity market drawdowns. Since the GFC, we’ve seen 20% decreases in equity markets and a maximum 3% drawdown in hybrids.
  • Hybrid return weakness is short term.
  • The risk factors and pattern of returns are uncorrelated to both equities and other income categories. High yield bonds and loan funds are more highly correlated to equities in a statistical and fundamental sense and if (and when) we do get a recession, they are more likely to fall by more than 10%.
  • Hybrids are liquid, with a few exceptions. Other higher-yielding income categories have unproven liquidity and are probably lobster pots (easy to get into, impossible to get out of). In stress, they will trade below their doubtful NAVs.

It's worth understanding Sharpe ratios

We’ll get a bit techie here, but the concept of risk-adjusted return is easy to understand. You want to earn more for investing in risky investments, if only because lots of volatility upsets investors and they sell at the wrong time. The Sharpe ratio measures the extra return for extra risk and is expressed as a ratio. If it is positive, it means that you have received extra return for the extra risk and the more positive the better. In the chart below, we show the Sharpe ratios for the Elstree Enhanced Income Fund (including franking credits but excluding fees) and the All Ords Accumulation Index over the past 10 years. We use the rolling 3-year ratio as a good timeframe over which to judge investments.

So, what does that tell us?

Since the GFC (when hybrid margins rose from the 1% pre GFC to average about 3.5% since), equities have returned 7.7% per annum compared to the Elstree Enhanced Income Fund (EEIF) return of 6.8% p.a. But because hybrids don’t have the annual 10% ups and downs that equities experience, the Fund has a Sharpe ratio of 1, which is twice as good as Australian equities.

Investors considering hybrids should take comfort from the following features:

  • Sustainable returns that aren’t much below prospective equity returns and well above cash.
  • Structurally lower risk than equities, and reasonable prospective risk (although lower than senior debt and subordinated debt in the capital structure).
  • Structurally different risk factors than other non-cash and bond asset classes.

Hydrids can be complex in structure and investors should consider the features of any instrument or fund before committing capital, but at least the threat of a removal of franking credit refunds from SMSFs has been removed.

 

Campbell Dawson and Norman Derham are Executive Directors of Elstree Investment Management, a boutique fixed income fund manager. This article is general information and does not consider the circumstances of any individual investor.

 

  •   29 May 2019
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

The fascinating bank hybrid journey of the last year

The end of the strong US dollar cycle

Today’s case for floating rate notes

banner

Most viewed in recent weeks

Building a lazy ETF portfolio in 2026

What are the best ways to build a simple portfolio from scratch? I’ve addressed this issue before but think it’s worth revisiting given markets and the world have since changed, throwing up new challenges and things to consider.

Meg on SMSFs: First glimpse of revised Division 296 tax

Treasury has released draft legislation for a new version of the controversial $3 million super tax. It's a significant improvement on the original proposal but there are some stings in the tail.

Ray Dalio on 2025’s real story, Trump, and what’s next

The renowned investor says 2025’s real story wasn’t AI or US stocks but the shift away from American assets and a collapse in the value of money. And he outlines how to best position portfolios for what’s ahead.

10 fearless forecasts for 2026

The predictions include dividends will outstrip growth as a source of Australian equity returns, US market performance will be underwhelming, while US government bonds will beat gold.

13 million spare bedrooms: Rethinking Australia’s housing shortfall

We don’t have a housing shortage; we have housing misallocation. This explores why so many bedrooms go unused, what’s been tried before, and five things to unlock housing capacity – no new building required.

10 things I learned about dementia and care homes from close range

My mother developed dementia before eventually dying in June last year. She was in three aged care homes before finding the right one. Here is what I learned along the way.

Latest Updates

Taxation

Is there a better way to reform the CGT discount?

The capital gains tax discount is under review, but debate should go beyond its size. Its original purpose, design flaws and distortions suggest Australia could adopt a better, more targeted approach.

Property

It's okay if house prices drop

The assumption that falling house prices are electorally fatal has shaped policy for decades. Evidence from upzoning suggests affordability can improve without reducing overall housing wealth.

Investment strategies

Investment bonds for intergenerational wealth transfer

Investment bonds can be a versatile and a tax-effective option for building wealth for longer-term investment goals. They can also be used as an estate planning tool, enabling the smooth transfer of wealth to younger generations.

Investment strategies

Why switching to income may make sense in 2026

Investors are jumpy as valuations continue to rise and income investing may provide a respite. In a challenging market for income investing AML offers their top picks.

Interviews

Retiring Schroders boss on lessons he’s learned, industry changes, and the market outlook

CEO Simon Doyle is retiring after 38 years in the finance industry. In an interview with James Gruber, he shares the three main lessons he’s learned, and where he sees opportunities and risks in markets today.

Investment strategies

How US midterm elections affect the markets

Investors may overlook the US midterms amid global events, but they could still impact markets. History shows markets react during midterm years, with increased volatility and lower returns. Will this year be any different?

Investing

Does increasing geopolitical risk lead to higher equity market returns?

Increasing geopolitical tensions has investors on edge but one study shows evidence of a war premium for equity markets.

Sponsors

Alliances

© 2026 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.