Hybrids are disappearing. Can ASX notes fill the gap?

Please note this interview was filmed Friday 13th March, 2026.

Let’s cut to the chase. What matters most for income investors?

It's income, everyone. Not a trick question.

But more importantly, reliable income. It's not about the why or what or who - it's about how.

With yield on the ASX increasingly scarce and bank hybrids set to be phased out by 2028, a wave of products are clamouring to fill the looming gap. 

Victor Rodriguez, EGM at Challenger Investment Management, is sceptical about how many of these solutions are being positioned. Challenger, a specialist in income-focused investing across fixed income and private credit, is taking a more measured and innovative approach.

I spoke to Rodriguez about how they’re navigating the balance between public and private markets, and their Challenger IM LiFTS Notes, a structure designed to deliver three key outcomes for investors - monthly income, a clear target return of 275 basis points above cash, and an equity buffer that absorbs first losses in the event of defaults.

Watch the full interview above, or continue reading below for the interview summary. 

INTERVIEW SUMMARY

Sentiment versus fundamentals

The narrative around private credit has shifted quickly. One of the fastest-growing asset classes, with explosive growth since banks reduced riskier lending, is showing signs of stress.

"There's no doubt cracks are starting to emerge," says Victor Rodriguez, executive general manager at Challenger Group Asset Management. But he says that investors risk misreading what's actually driving the noise.

"Our view is that, for the most part, that's driven by tight valuations and sentiment and less so today about fundamentals," he says.

The sentiment shift has been spurred by a growing number of retail and evergreen funds that have built-in withdrawal mechanisms.

When concerns emerged, particularly around software sector exposures, retail investors started pulling back, reversing what had been a period of unusually strong demand that pushed valuations up. Leverage in offshore vehicles also amplified this effect.

"You've also had a lot of leverage embedded in offshore vehicles and that can magnify valuation impacts when demand exceeds supply. You see valuations really run hard and now you're starting to see the reverse of that," says Rodriguez.

On the other hand, true credit fundamentals remain solid. Rodriguez points to the US, where default rates are running at 4–5% and loss rates at 1–2%. 

Even in the software space, the sector most under scrutiny, he says the underlying credit position remains reasonable today, despite a known maturity cliff approaching in 2028 and the very real threat of AI disrupting business models.

Domestically, it’s been a similar theme with a notable exception - residential and property construction risk on the lending side. “That has grown quite appreciably," says Rodriguez. “It's benefited from a lower rate cycle previously, but we think there's potentially higher risks in that space starting to emerge.”

Separating quality from weakness

Rate normalisation has reshaped the playing field. “We like to talk about the punch bowl sort of being put in front of investors and then taken away and now reintroduced through lower rates,” Rodriguez says to describe what has ostensibly led to a lessening of underwriting discipline and looser standards.

His view is that this environment will start to differentiate private credit managers, separating the wheat from the chaff.

"As things start to become a little bit more pressured, we think that there'll be a greater distinction between the quality managers who are doing the underwriting, who have got the discipline and those that are less so."

Rebalancing between public and private

Rodriguez notes that Challenger has been overweight private credit but is now reassessing that position. 

Illiquidity premiums are compressing, and public credit is starting to look comparatively better value. Their funds, including the Challenger IM Lifts One Notes, have the flexibility to move between both public and private markets.

"Public markets tend to react more quickly, particularly during risk-off periods," Rodriguez notes. "And so what happens is spreads in public markets widen more rapidly than you see in private, which starts to balance the ledger a bit more towards public credit."

The hybrid replacement conversation

With around $35 billion in bank hybrids coming to maturity over the next few years, there's been no shortage of products positioning themselves as replacements. 

Rodriguez is sceptical of some of the framing of these products. "I think there's been a lot of traditional products that are saying, 'This is the substitute.'"

The Lifts Notes, which are listed on the ASX and target a return of 275 basis points above the cash benchmark, are structured differently from most alternatives, Rodriguez says. 

“[It's] ultimately a fixed income investment. It's not an equity investment like the LITs that are well known in the marketplace."

He says that one of the concerns of the many options out there, which Challenger looked to address by bringing the Lifts Notes to market, has been that the focus has been on the headline rate and the historical return, rather than the risk profile of the product.

The key feature of the Challenger Lifts Notes is an equity buffer - a first-loss layer that sits beneath the note, absorbing defaults before they reach investors in the note itself.

“We thought particularly in this environment of increased regulatory focus, that bringing a product that not only provides attractive income returns for investors, but manages that risk profile in a very prudent and client-friendly way was really important.

"In the spectrum of products out there, because of that first loss buffer and the quality of the underlying collateral as well, we're at the more conservative end of that spectrum," he says.

The real gap in the market

Rodriguez says the biggest gap in the private credit market that still needs work is the regulatory oversight and how risk is communicated to retail investors.

ASIC has the sector well in its sights, as per its review and recommendations. Transparency around fees, valuations, and how risk is actually communicated is narrowing, says Rodriguez, but the work isn't done.

"How we're communicating, and how managers are communicating the risk profile of different innovative structures to a retail audience, is really the gap that is starting to narrow, thankfully - but I think there's still some work to do as we focus on prioritising outcomes for customers." 

Challenger IM LiFTS 1 Notes (ASX: CIMHA)

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