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Bond managers clash on surging hybrid debt market

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Standard Life Investments and Rathbone ethical bond managers have clashed over the opportunities on offer in the growing hybrid bond market.

Issuance in the corporate hybrid debt market, which involves bonds with some equity-like characteristics, has soared in recent months. Almost €15bn in hybrid bonds were issued in the opening three months of 2013, compared with around €5bn and €3bn for the whole of 2012 and 2011 respectively.

Standard Life Investments’ £154.9m Ethical Corporate Bond fund co-manager David Sol says the surge in hybrid bond issuance may offer investors a “relatively untapped yield opportunity” if they are aware of the risks involved.

He says: “Investors are right to pay close attention to the risks associated with hybrid debt. Clearly, a thorough understanding of corporate fundamentals is essential before investing in these instruments, hence our preference for names with robust balance sheets.

“However, we believe that there will continue to be selective opportunities to gain exposure to companies in this market at attractive pricing levels.”

Sol, who manages the fund with Andrew Sutherland, highlights the risks with hybrid bonds include the fact they rank below all other debt obligations in a company’s capital structure and some structural concerns such as the “considerable flexibility” firms have in the calling and resetting of coupon payments.

Rathbone Ethical Bond fund manager Bryn Jones, on the other hand, remains “undecided on hybrids” because of these risks and has avoided making a play on the market so far.

He says: :I don’t think you are getting paid for the extra risk you are taking. You are taking on quasi-equity risk, as far as I am concerned, just for an extra 50 or 100 basis points and that is not enough.

“If financials spreads and financial subordinated spreads were a lot tighter and I had to take a look, then there might be some value in some of them but I still think you can get better value in the financial space.”

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