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

The strange effect of the 30% minimum capital gains tax

The 30% minimum tax on capital gains sits at the heart of the budget's proposed reforms. Yet the mechanics reveal anomalies that introduce unexpected distortions that raise questions about its design.

Does your will qualify for the discretionary testamentary trust exemption?

Treasury has confirmed the exemption many families were hoping for. But buried in the fine print are two conditions that could leave some wills on the wrong side of the exemption, despite years of careful planning.

Ranking three common retirement strategies

The defining challenge of retirement isn't just about building wealth, it's about converting your lifetime savings into sustainable income. A holistic understanding of different strategies can improve long-term outcomes.

Are you making these SMSF mistakes?

After four decades advising investors, there are a few common mistakes I've seen SMSF investors make. From holding too much cash and chasing yield to overtrading and trusting tips. Are these errors costing you?

Why Australian shares are falling behind the world

Australia’s market boasts a long record of outperformance, but recent results tell a different story. Is the ASX’s lagging performance a temporary setback or evidence that structural forces will keep global markets ahead?

Australia has saved $4.5 trillion for retirement. Here's what matters more

Most Australians approaching retirement can tell you the exact dollar value of their super account. But success depends on more than a sizeable balance. Here's four key questions to ask yourself at the start of the financial year. 

Latest Updates

Economy

Why have Australian living standards 'fallen' and how do we fix it?

For the last few years there has been much talk of a 'cost-of-living' crisis in Australia and of 'falling living standards'. Lately this has flared up again with the pickup in inflation resulting in a renewed fall in real wages.

Latest from Morningstar

Four options for an income investor’s next dollar

What if Australia’s golden age of dividends is ending? Rather than overhaul your portfolio, it may be worth considering where new capital can work harder. I discuss four income strategies and the trade-offs behind each.

Taxation

Completing the reform of CGT: tax real losses like real gains

Recent CGT reforms tax real gains by indexing capital gains to inflation. However, the reform fails to index losses, leading to higher tax on assets that do not keep pace with inflation, creating inefficiencies in the tax system.

Investment strategies

Blockbuster AI debt issuance coming to a bond market near you

With Australia likely to attract a growing share of AI-related issuance, investors should prepare for increasing influence from AI funding demands, evolving credit fundamentals and changing valuation dynamics.

Investment strategies

Active managers: Bringing a gun to the gunfight

When data arrived, basketball abandoned the mid-range shot, Formula 1 reinvented the pit stop and chess embraced humans working with machines. Active managers confronting today's markets may learn from the same path.

Retirement

What Australian super funds can learn from the UK

Most people want answers to three retirement questions: What have I got? Is it enough? What can I do with it? A leading UK pension innovator shares his lessons on helping members better understand and prepare for retirement.

Investment strategies

What the market may be missing in FY27

We asked ten fund managers the same question following FY26. While their investment styles differ dramatically, their answers revealed several surprising areas of agreement about where markets may be heading next.

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.