You only have to look at the recent performance of hybrid securities to realize that debt-like securities can have equity-like characteristics. As we witnessed during the GFC, equity hybrids act like debt in rising markets and equity in falling markets, which raises the question for many investors – how much risk is being taken in the pursuit of yield? The answers may be found in the new Gryphon Capital Income Trust (ASX:CGI) IPO.
For a long time, investors have had a limited choice in the securities they could buy for income purposes. As far as income-producing assets are concerned, the typical SMSF portfolio usually holds cash term deposits, bank shares and hybrids, and an investment property (if they’re lucky). The attractiveness of franking credits has made bank shares and hybrids an overweight position. But the volatility associated with this exposure can put capital at risk in times of market stress or when, as Bill Shorten proved, changes to regulations threaten franking cash refunds. The risk of capital loss is best illustrated by the chart below which shows the recent performance of a sample of longer-dated ASX-listed hybrids (Additional Tier 1) against the performance of Gryphon’s proxy institutional strategy.
Gryphon Capital has been managing institutional mandates in the structure credit space for several years, and currently has approximately $1.7billion under management, principally in secured bonds such as Residential Mortgage Back Securities (RMBS) and Asset Backed Securities (ABS). RMBSs are asset backed by houses; ABSs by cash flows from leases and credits cards. The objective of the Gryphon Capital Income Trust (ASX:CGI) is to deliver a 5% net return paid monthly to investors with low capital volatility. The new listing will for the first time enable retail investors to have access to an institutional grade strategy and, key in times of increased market volatility, offer them an alternative to cash term deposits and equity-like yielding instruments.
An equally important question, not just with regard to Gryphon Capital but also for holders of bank shares and bank hybrids that are highly leveraged to the same risk, is “How will a collapse in property prices affect those with exposure to residential mortgages?”. As a part of their risk-management strategy, Gryphon Capital stress test their portfolios for this exact occurrence, using APRA’s 100- and 200-year event, which equates to a 40% fall in residential house prices. In this environment Gryphon Capital want to ensure that their investors’ capital is protected.
What we do know is that markets tend to highlight risks with small signals before those risks plays out, whether they be market-related or politically driven like Bill Shorten’s proposed crackdown on franking credits. As it has done in the past, the hybrid market is now showing us that these debt-like securities may possess equity-like risk profiles. The role of a strategy like the Gryphon Capital Income Trust (ASX:CGI) is best understood by reference to the bank funding model, where term deposits rank highest in the event of a default followed in descending order by secured debt (such as RMBSs and ABSs), unsecured debt, hybrids, and equity. That risk is reflected in the income an investor would expect to receive for holding the asset.
While retail investors can’t stress test portfolios against the risk of a collapse in property prices, the defensive alternative doesn’t always have to be cash term deposits at 2% per annum. Cash and equity exposure are not the only income producing asset classes. We have seen in recent times the success of strategies like global equities and long/short become more mainstream in retail portfolios. This should be the case with secured bond strategies like the Gryphon Capital Income Trust (ASX:CGI). Australian investors need fixed income exposure to provide true diversification.
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