With interest rates on the decline, reliable income options are becoming increasingly hard to come by. Share dividends are risky and can be unreliable, while bonds are offering low yields and are exposed to interest rate risk. Is the BetaShares Active Australian Hybrids Fund (ASX: HBRD) the solution?
What are hybrids?
A hybrid is a financial product that combines characteristics from two or more financial instruments, typically debt and equity securities. This means that a hybrid security will share some characteristics of both bonds and shares.
A good example of this is a preference share. Preference shares, like common shares, are a part-ownership of a business. However, there are a few key differences between the two. Preference shares pay dividends that are typically fixed or paid at a predetermined rate, for example, 4% above the Bank Bill Swap Rate (BBSW). This means that preference share dividends can change with interest rates, but they are usually more stable and predictable than common share dividends, which are typically determined every six months by the board of directors — at their sole discretion.
Preference share dividends also receive priority over ordinary dividends but are paid after coupon payments for bonds. In the event of bankruptcy, bondholders would be paid first, then preferred shareholders, then if there’s anything left over the common shareholders might get something back. So, preference shares offer greater security than common shares because the dividends are more reliable and predictable and they take priority over common shares if the company goes bankrupt.
Importantly, preference shares are typically much less volatile than common shares and the two asset classes have reasonably low correlations with each other. The impact of this is two-fold. First, the reduced volatility makes preference shares more defensive than common shares and the low correlation can make them an effective portfolio diversifier.
Second, it means that preference shares don’t have the same potential for capital growth that common shares do. Because they offer fixed dividends and more security than common shares, their pricing and growth potential is often more comparable to bonds than shares.
Another downside to preference shares is they rarely come with voting rights, meaning you are still a part-owner of the business but you don’t get a say in how the business is run.
HBRD – the income solution?
The BetaShares Active Australian Hybrids Fund is an actively managed ETF that invests in a portfolio of hybrid securities, namely preferred shares. The ETF is managed by Coolabah Capital Investments, an experienced active manager in the credit and fixed income space.
While most of HBRD’s holdings are preference shares (around 85%), its active management strategy allows funds to be moved into cash, bonds, or capital notes if the hybrids market is deemed to be too risky. This can help to minimise interest rate risk and can be an advantage over a passively-managed bond ETF, like the iShares Core Composite Bond ETF (ASX: IAF).
In terms of income, HBRD currently has a 12-month trailing distribution yield of 2.9%, but after considering the impact of franking credits this is grossed up to 3.8%.
While this is an appealing yield and better than most bond ETFs, it’s important to note that active management doesn’t come cheap. HBRD charges a management fee of 0.55% per year as well as a performance fee of 15.5% of performance above its benchmark.
For those investors seeking income for their portfolio, HBRD could be an option worth considering for its higher yield and lower interest rate exposure compared to bonds, and its stability and reliability compared to shares. Don’t forget, this higher return does come with additional risks, so be sure to read our full report on HBRD and always read the product disclosure statement (PDS) before making an investment decision.