SMSFs drawn to the danger zone

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Advisers are being called on to warn their clients about the dangers of hybrids, particularly SMSFs who have little knowledge of the risks.

About 75,000 investors, two-thirds of whom are SMSFs, are investing in hybrid securities, but less than half are being helped by financial advisers, according to ASIC.

Hybrid securities often involve heightened risk for clients when compared to other investments like vanilla bonds. Advisers are encouraged to discuss whether the promised returns adequately compensate for the investment risks – particularly when compared to less risky or shorter term investments – and whether a particular hybrid security will help them achieve their personal goals.

Where the security is issued by a bank, investors may assume their investment is ‘safe’, and often see hybrid securities as an alternative to bank term deposits, or fixed income investments.

But as shown by ANZ in February this year, anything can happen to influence when redemption may occur, if at all. The decision by the bank not to call a retail hybrid they issued in New Zealand five years earlier raised concern about whether it would serve as a precedent for other Australian banks, particularly given the security now pays a lower interest rate. Macquarie Income Securities and National Income Securities continue to pay interest more than 13 years after they were issued.

The older hybrid securities have operated according to their terms, but all may be considered to have ‘failed’ to a greater or lesser extent because they have not fulfilled the expectations of investors—whether by remaining on issue and not returning capital to investors, ceasing to make interest payments, or becoming almost worthless following the collapse of the issuer.

ASIC is urging issuers and their advisers to devote considerable time and effort to make the security, its features and risks as comprehensible to clients as possible – using plain or direct language in the ‘Investment overview’.

“Our focus is on ensuring the ‘Investment overview’ section explains the key features in a way that retail investors can understand,” said ASIC. “This involves focusing on the question, ‘What does an investor really need to understand about this offer?’.”

The ‘Investment overview’ section is then followed by the ‘About the security’ section, which ASIC wants to be made as short as possible.

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