Replacing Australian Bank Hybrids: Global Insights and Income Alternatives
Text on screen: Kanish Chugh, Head of ETF Sales
Chugh: Australian bank hybrids or AT1 bank capital are a key component of Australian portfolios. APRA's recent changes have meant that $40 billion of the hybrid market is going to be phased out by 2032.
Now, this particular change is representing both challenges and opportunities for Australian investors as they look for alternative sources of income.
It's really great to have both of you here, Philippe Bodereau, Lead Portfolio Manager for Global Financials and Rob Mead, Co-Head of the APAC portfolio management team.
I believe both of you have worked together for over 20 years.
So from a global perspective, are we seeing similar changes or challenges in bank capital structures, and what are the global trends and opportunities that Australian investors should be aware of Philippe?
Text on screen: Philippe Bodereau, Portfolio Manager and Head of Credit Research, Europe
Bodereau: So I would say that the Australian decision was pretty unique and idiosyncratic decision that only effects this country. I think probably part of the reasoning over here was that this was a pretty unique market that had developed, as being a primarily retail-oriented market, which is not the case of other countries that are following Basel III implementation, where the AT1 market is, by and large, developed as an institutionally focussed market.
So, the market in Europe, in other parts of the world is still growing. There are always debates around suitability and the nature of those instruments at my place in Europe, but there's certainly no notion that they should be cancelled or phased out at all. If anything, we continue to see reasonable growth in that market.
Chugh: And Rob, turning to yourself, given that global perspective, how should Australian investors think about replacing that alternative, hybrid position in their portfolios?
Text on screen: Rob Mead, Co-head of Asia-Pacific Portfolio Management
Mead: It's a really good question. And it's something that's been debated across the whole market, as you know. I think one of the really important things to think about though, is that part of the reason that hybrids was so popular and attractive to Australian investors was because of the franking credits.
And so when it comes to thinking about how to replace that in a portfolio, you really need to think about how to replace an after-tax yield and something that we've been spending a lot of time and effort on.
So what we did was a full, rigorous analysis to think about how an investor should replace their hybrid exposure and how they should try to replicate the yield expectation. And so we went away, put together some analysis, and I think there's some really important takeaways that investors should be focusing on.
So I'll run through those. So the first one is you don't need to replace it one for one with private credit. You don't need that much yield.
So the really important takeaway is maybe give 25% of that allocation to private credit. The rest of it should be in daily liquid core bonds, multi-sector credit, all the things that are available directly in a fund or an ETF. So it's a really, really good outcome.
The third thing is that things like the portfolios that Philippe manages, they're a great diversifier similar part of the capital structures globally but diversified away from other opportunities.
The fourth thing is we don't include any high yielding, high dividend, expensive Australian stocks in the solution.
And the final thing in our hybrid replicating yield portfolio is that we actually end up with about a 20% lower tail risk expectation. So more liquid, less risk, and a very similar yield to replace what’s the hybrids in portfolios currently.
Chugh: Rob, really great insights on what Australian investors can do now to replace their hybrid exposure.
And Philippe, that's some really interesting insights from a global perspective that we don't normally hear from.
Now for both of these pieces and for both of these perspectives, and in particular, the latest insights on what we can do to replace our Australian bank hybrid exposure, you can visit our website, pimco.com/au, to access all of that information.