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

How cutting the CGT discount could help rebalance housing market

A more rational taxation system that supports home ownership but discourages asset speculation could provide greater financial support to first home buyers.

Want your loved ones to inherit your super? You can’t afford to skip this one step

One in five Australians die before retirement and most have not set up their super properly so their loved ones can benefit from all their hard work and savings. 

Super is catching up, but ageing is a triple-threat

An ageing Australia is shifting the superannuation system’s focus from accumulation to the lifecycle of retirement. While these pressures have been anticipated for decades, they are now converging at scale and driving widespread industry change.

Has Australia wasted the last 30 years?

The 20 years after Peter Costello left Treasury have been deemed wasted...by Peter Costello. The missed opportunities for Australia began long before.  

Meg on SMSFs: Last word on Div 296 for a while

The best way to deal with the incoming Division 296 tax on superannuation is likely doing nothing. Earnings will be taxed regardless of where the money sits, so here are some important considerations.

The 5% deposit scheme is bad for homeowners and Australia

An ‘affordability’ scheme making the county more vulnerable to economic shocks and contributing to the deteriorating financial situation of everyday Australians.

Latest Updates

Investment strategies

The thin line between investing and gambling

Prediction markets are blurring the line between investing and speculation and savvy investors can profit from this trend by heeding the advice of famed investor, Benjamin Graham.

Strategy

The refinery problem: A different kind of energy crisis in 2026

The Strait of Hormuz closure due to US-Iran conflict severely disrupted global energy supply chains. While various emergency measures mitigated the crude impact, the refined product market faces unprecedented stress.

Gold

Are we running out of gold?

Geopolitical instability and challenges with new gold discoveries mean we may be approaching a structural shortage of mineable gold, but what does this mean for gold's overall long-term availability?

Investment strategies

ETF investors adding to portfolios during recent volatility

In the face of recent market volatility investors continue to add to their ETF portfolios with these ETFs getting notable inflows, indicating that long-term fundamentals remain solid.

Strategy

Policy setting in democracies

Democracies aren’t a given, and policymakers need to be mindful not to alienate communities and instead be more aligned with mainstream ideas and attitudes. 

Investment strategies

Take my money and lie to me… again

As private funds increasingly show signs of cracking and buckling under a complete lack of liquidity, the salespeople do their best to keep the cash pouring in from new investors. 

Economy

Australia was once a world leader in innovation, now the system is ‘broken’

Ambitious Australia joins a long line of reports examining research and development, finding Australia has fallen behind its peers on many fronts. It urges bold reform to address declining productivity and research spending.

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.