Capital securities: Why these hybrid investments may offer a compelling risk/reward profile

Capital securities are a nuanced and overlooked asset class that, in our view, may be an attractive addition to a broader fixed income portfolio. A hybrid asset class that can share characteristics of both bonds and stocks, capital securities include structural features that provide corporations with regulatory or rating agency capital treatment without diluting common shareholders. Issuers often pay rates on capital securities well above those of senior bonds, subordinated bonds, and equity dividends. We believe that there are enduring structural inefficiencies in the capital securities market that provide the potential for a compelling risk/reward profile for investors.

High-yield potential from higher-rated securities

For the 10-year period ended 30 June 2024, capital securities (rated BBB3) matched the pre-tax returns of high-yield corporate bonds (rated B1) on a total and risk-adjusted basis (Figure 1). Approximately 66% of the yield of capital securities as of 30 June 2024 came from securities rated BBB or higher. For high-yield corporate bonds, 56% of the yield came from securities rated B or lower. Put simply, the historical returns and present yields compare to those of high-yield corporates but come from higher-quality credits.

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