The end of hybrids: What replaces them in your portfolio?

Please note this interview was filmed 22nd August, 2025.

Risk is an ever-present word when it comes to investing. Yet it’s not often we see risk become so hard to ignore that regulators make a decision that effectively creates a $40 billion-sized hole in the market.

The collapse of Credit Suisse in March 2023, following a series of prolonged scandals and management failures, culminating in a takeover by its rival, UBS, was one of the catalysts that led to APRA’s decision to phase out Australian bank hybrids (AT-1s) entirely by 2032.

For many retail income investors, though, the termination of hybrids is going to leave a significant gap in their portfolio as a reliable source of income bites the dust, and naturally, investors are looking for the closest possible replacement.

In the interview above, Blair Hannon of Macquarie Asset Management unpacks hybrids, why they mattered, and where investors might turn next. Watch the video for the full insights, or read an edited summary below. 

Why hybrids hit the sweet spot

Hybrids carved out a niche in Australian portfolios, offering accessibility and reliable income with the added benefit of franking credits.

“For a lot of investors, they were that midway point - a way to access reliable income from corporations they knew and trusted,” Hannon explains.

Accessibility was key. “Bonds can be tough to access for retail investors. Minimum allocations used to be $500,000 to a $1 million dollars." 

Hybrids, being listed on the exchange, lowered that bar significantly. And the other big drawcard, of course, was franking credits. 

“We all know how in love the Australian investing public is with franking credits,” says Hannon.

Hybrids provided investors with another way to access them, while helping banks clear excess franking credits off their balance sheets. Put those two things together, Hannon says, and it created a real ‘Goldilocks zone’, one especially appealing to retirees.

Why APRA is winding them down

In late 2023, APRA announced that hybrids would be phased out over the next decade. The move, Hannon says, was about protecting investors and ensuring the stability of the banks.

“A catalyst was what happened with Credit Suisse in Europe. They had hybrids, and when the bank collapsed, those investors were wiped out."

"If you think about how many retail investors had these instruments, the question I think in APRA's mind was, do they really understand the risks of what hybrids are?"

The crux of the issue is that hybrids combine debt and equity. In times of stress with those banks, APRA can step in and convert them into shares, explains Hannon. 

However, APRA ultimately judged that the risks outweighed the benefits.

Banks can replace hybrids in their capital structure with subordinated debt, which are over-the-counter institutional products.

Australian banks don’t have a funding issue, thankfully, but the problem is that there is no direct replacement for investors that combines franking with accessibility.

The investors most affected

So who feels the impact most? According to Hannon, it’s those who relied on hybrids for both yield and franking credits.

“You could get a grossed-up yield that was significantly higher than the actual dividend that you were getting from that bank. So if you combine those two, because the likelihood was that the investor in the hybrid of - let's just say CBA - likely had CBA shares as well."

With hybrids gone, he says fixed income ETFs and bond funds are already emerging as potential replacements.

“Over time, ETFs have become a way to access bonds, which were otherwise difficult for retail investors."

Where the $40 billion will flow

The phase-out leaves around $40 billion in hybrids set to be wound down. Hannon says investors can be confident they’ll get their money back.

“APRA wants the banks to repay them. That capital will flow into cash first. From there, people might consider term deposits, cash at call, or other cash products. Bonds are another option, though again, accessibility is an issue unless you use ETFs or managed funds.”

Hannon warns against rushing into high-yield products being marketed as hybrid replacements.

“We’re seeing some very high-yield offerings that aren’t in the same risk bucket as hybrids. Investors really need to do their due diligence. Hybrids were valued for their accessibility and franking credits and often tied to a bank you already held shares in."

ETFs or bond funds bring diversification, which is positive, but as Hannon stresses, you need to understand what’s under the hood.

What investors should weigh up

When asked about the most natural replacement, Hannon points to subordinated debt as the closest equivalent, the very product APRA is mandating banks to use in place of hybrids; however, there’s no perfect one-for-one replacement.

“We're certainly having a lot of conversations around that with investors.” Hannon says.

The choice, as Hannon explains, is whether you want a very targeted sleeve of subordinated debt or a broader bond or credit fund. Hannon says it depends on your portfolio, your income goals and your risk tolerance.

The case for fixed income ETFs

ETFs are increasingly popular among income investors. Hannon is bullish on their role.

“An ETF is just a wrapper, so you can put anything liquid inside it. Bonds are very liquid at the institutional level. ETFs bring that liquidity to the exchange for retail investors.”

While ETFs are often synonymous with passive investing, Hannon argues fixed income is a different story.

“Passive works beautifully in equities, because companies that grow get a bigger weight. That reflects economic success," he explains. "But in fixed income, if you weight by debt outstanding, the most indebted companies get the highest weight. And in bonds, the number one goal is to avoid defaults.”

That’s where active comes in. 

“When you lend money, you want someone assessing whether it’s likely to be paid back. Passive doesn’t do that. Yes, costs matter, but in fixed income, active management can add real value.”