Hybrid security is a type of financial security which is having the features of both debt securities and equity securities. Like debt securities, Hybrid securities also provide a rate of return until a certain date, however, they may pay a higher rate of return than regular debt security due to its equity-like features. An investor may decide to buy a hybrid security to improve the return on capital as the return from hybrid securities is generally more than the interest paid on simple bonds.
There is a variety of hybrid securities quoted on Australian Stock Exchange (ASX) which can be broadly split into three categories –
- Convertible Debt Securities – These are the debt securities that could be converted into equity securities as these securities provide either issuer or the investor an option to convert their debt security into equity security at a specified date in the future.
- Preference Shares – These are equity securities which are having debt-like features. Unlike ordinary shares which are having variable dividend rate, the preference shares usually have a fixed or floating specified dividend rate. A preference share holder is generally given preference over ordinary shareholders at the time of payment of dividends and at the time of recovery of capital.
- Capital Notes– These are debt securities which are having equity-like elements in it. For example- Perpetual debt securities, subordinated debt securities and knock-out debt securities. Like Shares Perpetual debt securities are having no fixed maturity date. The payment of interest and repayment of principal of subordinated debt securities are subordinated to another class or classes of debt and the subordination could be in favor of the holders of senior debt or to ordinary creditors.
Some hybrid securities like subordinated convertible debt securities or convertible preference shares are having combined features of above-mentioned hybrid securities. There is generally a higher level of risk attached to a hybrid security than to a regular bond which is why sometimes most hybrid securities pay higher returns than regular bonds. There are various types of risks associated with hybrid securities which include interest rate risk, credit risk and liquidity or marketability risk and it is very important to understand the degree of risk associated with different types of investments to make an informed decision while investing in the securities.
An investor can buy hybrid securities from a primary market or the same may be bought through a secondary market. Buying from a Primary market means that the investor buys it directly from the issuer and buying from secondary market means that the securities are bought on securities exchange platform like ASX. Hybrid securities are generally complex in nature and riskier than other forms of investments, which is why investors should understand the conditions of these securities and should obtain advice from a professional financial adviser before making any final investment decision.
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