Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 607

Now might be the best time to switch out of bank hybrids

This is an edited transcription of an interview between Firstlinks’ James Gruber and Helen Mason, Fund Manager of Schroders’ Australian High Yielding Credit Fund (Cboe:HIGH) on April 7, 2025.


James Gruber: Can you outline what type of securities your fund invests in?

Helen Mason: We buy corporate and financial credit. Companies and financial institutions come to the Debt Capital Markets (DCM) to borrow money, when they have a general financing needs or there is capex that needs to be funded. Investment houses like Schroders assess the credit quality of these businesses and decide if we want to lend to them and if so, at what price. In return, we receive a regular coupon payment and expect to receive our principal back at the maturity of the bond. That's ultimately what credit is.

We define our credit universe for the Schroders Australian High Yielding Credit Fund as Australian companies issuing in any currency across the world. For example we can buy a CBA bond in USD, EUR or even GBP and offshore companies, such as Barclays Bank issuing into the Australian credit market in AUD. All currency risk is hedged back to AUD. The Fund does not take currency risk.

We don't buy structured credit in this fund because structured credit is just less liquid than senior and subordinated bonds. Liquidity is important to us because the fund offers daily liquidity to its investors. Furthermore, we do not allow any private debt holdings for the same reason. Transparency is important to our investors.

JG: How have Trump’s tariffs impacted credit markets?

HM: High yielding US credit has underperformed the most significantly, however that was to be expected given valuations on US high yield have been extremely expensive for quite some time.

ICE Bofa US high yield effective yield

Source: Trade Economics

Australian credit has held up pretty well. Australian Major bank Tier Two (T2) paper in is out circa 40-45bps whereas Kanga T2 [Kangaroo bonds] is out 50-55bps. It could have been a lot worse. We're actually pretty comfortable with how the market has behaved so far.

It's not liquid at the moment; no one's really doing any deals. No corporates are coming to the market. It's very hard to price a new deal in markets like this, so you just get less liquidity. But overall, we haven't seen a capitulation.

JG: You've got some cash on hand. Where do you see the opportunities to put that cash to work?

HM: Wholesale tier one [bonds] for us had been trading above par over the last few months, and it really has been getting more expensive, but we've been able to transact in the markets now below par, and actually quite significantly below par. That's great from the perspective that firstly, they're very short duration - one and a half to two years left on these particular bonds - and we'll be repaid at par. But also the spread - the credit risk premium attached to those bonds - at the moment is extremely high, and we're waiting for more opportunity for those types of bonds to come out.

JG: A lot of investors have been switching out of hybrids into tier two, or unsubordinated bonds. How do you view these bonds?

HM: I really like tier two bonds. You're still getting an investment grade quality paper, but it's subordinated, and it prices significantly wider than other IG [investment grade] credit. There is an argument to say that Australian major bank tier two had become very tight prior to the events of the last week. This repricing that's happening now is actually going to create better value to get back into tier two.

JG: What would your advice be to those investors still holding onto hybrid securities?

HM: A paper that I wrote recently demonstrates that having a diversified allocation to credit is important, particularly in times like this when there is a lot of volatility in markets. The other point is that retail bank hybrids are still trading above par. So if you are looking to reallocate, probably now's the time, because they will end up at par - when you get repaid your 100 cents in the dollar.

JG: A lot of your fund is invested in Triple-B securities. Triple-B is down the pecking order in debt ratings - why do you like them?

HM: Ratings from triple A all the way through to triple B minus are still investment grade ratings. So the fund that we manage is still an investment grade fund.

We look at triple-B corporates because if you actually look at excess returns to per unit of risk, then the triple-Bs are delivering you a better return versus the risk over a long period of time.

But also in Australia, we have quite a unique setup for our triple B's, and that's because we're so dominant on heavy critical infrastructure in Australia. The airports, the ports, the toll roads, railroads - these are essential businesses, and they have very stable ownership.

What we like about them is that because a number of them are regulated, particularly electricity distributions and gas pipelines, we get a clearer view of cash flow transparency.

JG: Where do you think lie the greatest risks in credit markets?

HM: Globally, I would have said US high yield a couple of weeks ago as it was priced very tightly for the risk you're taking. If you think about the index in Australia, it's rated A plus, whereas the US high yield index, it's sub investment grade in the double-B space. You've got big differential in rating there. But also, even in US and European investment grade credit, they're rated two notches lower than Australian credit as well. We're just very high quality here versus other places in the world.

One of the areas that we had taken some risk off the table was the energy companies like Santos, for example. But not because we don't like Santos, but more because we just weren't getting paid enough of a risk premium. Prices were getting very tight on names like Woodside and Santos.

JG: Why do you think active management in the credit space is important?

HM: A lot of the ETFs that have come into this space are very much focused on tier one and tier two, which are just Aussie financials.

True diversification can come from investing in other great Australian companies - our critical infrastructure, utilities, and even some of our consumer staples, Coles and Woolworths, are triple-B companies.

 

Helen Mason is the Fund Manager of Schroders’ Australian High Yielding Credit Fund (Cboe:HIGH). You can find out more about the fund here. Schroders is a sponsor of Firstlinks. This material is general information only and does not take into account your objectives, financial situation or needs. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this material.

For more articles and papers from Schroders, click here.

 

5 Comments
Ben
April 24, 2025

Interesting article. It’s good to have a better understanding of what alternatives there are to hybrids for income investors in Australia.

Brian
April 21, 2025

We,ve held bank hybrids for many years and are disappointed they are being phased out, but I haven,t yet found a compelling argument why we should pay a fee to have someone invest on our behalf on what are inferior products with lower returns.
There are still a number of hybrids with first calls dated 4-5 years ahead which even allowing for say a gradual reduction in bbsw rates of 2% can still pay an average franked interest over time of circa 6% and even allowing for an ultimate capital loss when called will still have paid a better return than other options I have explored.

Ralph
April 18, 2025

So what are the options for SMSF's who hold $50K to $100K spread over 3 or 4 hybrids? Non sophisticted investors are excluded from a lot of the bonds or may not want the concentration.
SMSF's invested in hybrids as the return, once franking credits were included, was good. I am not sure that another ETF focused on a range of bonds is an adequate substitute.

Neil
April 18, 2025

Given the vast majority of the article is not about hybrids but rather (potentially a promotion) an overview of Helen Mason’s HIGH product, I think the headline “Now might be the best time to switch out of bank hybrids” is a little misleading.

Ian Lange
April 18, 2025

agree with Neil - had the Headline reflected what was in the core of the article, I wouldn't have bothered to read it.
We expect more from Firstlinks !

 

Leave a Comment:

RELATED ARTICLES

Things may finally be turning for the bond market

Are we going through a 'bond market rout'?

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Latest Updates

Retirement

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

Shares

Boom, bubble or alarm?

After a stellar 2025 to date for equities, warning signs - from speculative froth to stretched valuations - suggest the market’s calm may be masking deeper fragilities. Strategic rebalancing feels increasingly timely.

Property

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Economy

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Shares

Is the iPhone nearing its Blackberry moment?

Blackberry clung on to the superiority of keyboards at the beginning of the touchscreen era and paid the ultimate price. Could the rise of agentic AI and a new generation of hardware do something similar to Apple?

Fixed interest

Things may finally be turning for the bond market

The bond market is quietly regaining strength. As rate cuts loom and economic growth moderates, high-quality credit and global fixed income present renewed opportunities for investors seeking income and stability. 

Shares

The wisdom of buying absurdly expensive stocks (or not!)

Companies trading at over 10x revenue now account for over 20% of the MSCI World index, levels not seen since the dotcom bubble. Can these shares create lasting value, or are they destined to unravel?

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.