The long goodbye to hybrids: What investors need to do now

Please note, this panel was recorded on 11 August 2026.

Few investments have attracted the kind of loyalty from Australian investors that bank hybrids have over the years.

Offering a combination of attractive income, franking credits and the familiarity of the big banks, Additional Tier 1 hybrids (AT1s) have become a much-loved staple of income portfolios.

But with APRA’s phaseout of AT1s beginning in 2027 and set to be completed by 2032, now is the time for investors to be thinking about what comes next.

To discuss the transition away from bank hybrids, I was joined by Rodney Sebire and Andrew Yap from Zenith Investment Partners, and Stephen Martin from Challenger Investment Management, to explain what it means for investors, what they need to be doing now, and how they should think about replacing hybrids going forward. 

For the full discussion, make sure to watch the video above.

INTERVIEW SUMMARY

Why hybrids are on their way out

Despite their beloved and entrenched status in Australian fixed income - a total of $34 billion of hybrids will end up being called over the phaseout - it was ultimately the collapse of Credit Suisse in 2023 that prompted APRA into action. 

AT1s sit above common equity and below Tier 2 bonds in a bank's capital structure and were designed as an additional layer of liquidity. But the real-world example of Credit Suisse saw US$17 billion of AT1 bonds wiped out ahead of equity holders.  

What it means for investors - and what they need to do now

What's important for investors to understand is that the transition is happening, but it doesn't need to have a seismic impact on their portfolios, says Challenger's Stephen Martin.

"I think over the last six to 12 months the reality has set in - this thing is happening, this thing is here to stay. And for end investors that means slowly coming to the realisation that they have to start making some decisions about what the future looks like."

Martin says the phaseout is happening concurrently with a wider trend in income markets where investors are searching for income. 

"Investors holding hybrids because they felt they were relatively liquid and an easy transferable asset, then over the next 12 months and beyond, that's going to change as the pool of available hybrids shrinks." 

For those investors, time is of the essence to ensure they're not caught out. 

"That market becomes more esoteric, potentially a little bit less liquid as well," says Martin. "And they need to be acting quickly to make sure that that job in the portfolio is being filled by something else."

For other investors, that time pressure is less pronounced, but still something that needs to be acted on.

"Perhaps with someone who's there as a long term, buy-and-hold investor, or maybe as a smaller component, they can act more slowly, but ultimately a decision is going to have to be made."

Zenith Investment Partner's Sebire says investors need to be aware of the potential volatility and liquidity issues to come. 

"If you're holding these assets, you need to have a yield to maturity focus because right now you're sitting there with a portfolio of bonds and depending on when the call date is, you're going to have bonds at $105-106 that are going to get called at a hundred." 

"So if you've got a yield to maturity focus and you're happy that you're going to have that pulled apart and working against you for the next three years, that's fine," says Sebire. 

"But as we get further into the phaseout period, the liquidity - the natural buyer is going to decline. So you're still going to be exposed to liquidity-induced volatility potentially."

Thinking about income portfolios post-hybrids 

For investors looking for alternatives to hybrids, Zenith's approach to credit portfolio construction can be a good starting point, says Andrew Yap. It starts with two considerations: their view on interest rates and credit. 

"Then it's about how do we structure a set of investments that is purpose-built for the current economic regime that we're in," Yap says. "An additional element there is that when we think about managed accounts as a structure, we need to focus on liquid exposures."

One such option is Challenger IM LiFTS 1 Notes (ASX: CIMHA), which, according to Martin, can provide some of the characteristics investors sought from hybrids.  

"In essence, what they are is a floating rate term security that we've issued, backed by a portfolio of public and private credit. That's what's generating those underlying returns and delivering strong and consistent, stable income to end investors, all done in a way that's liquid, daily tradable by the assets and price frequently."

Despite their popularity, and the fact they offer the name recognition of the big banks, hybrids in actuality have "quite complicated capital structure", says Martin. What products like LiFTS offer is more transparency on the underlying portfolio, but that also means the onus is on investors to understand what they're investing in.

"What listed notes offer is the ability to invest in selected pools of assets that different managers put together," says Martin. "So our list product might look different to the next listed note down the line."

It's also about providing investors the certainty on maturities that hybrids have offered. 

The phaseout of hybrids has also encouraged wider market innovation, says Martin. 

"[LiFTS] was the first listed note of its kind," he says. "But what we've seen is a couple of other managers come out after us and issue behind us, which has been really pleasing and we're looking to see this market grow and evolve."

The panel's key takeaways

Our panellists were also asked for the core message they wanted investors to keep in mind as part of the hybrids phaseout. 

According to Sebire, the phaseout presents a good opportunity for income investors to reset and move away from bank capital.

"Spreads are really tight across the whole curve," he says. "A lot of the senior sub ratios that we look at are really compressed. We've just got a breadth of choice now and there is nothing unique about hybrids returns apart from the feel-good factor."

"The one message would be divorce your love affair," he says. "There's plenty of spread sectors, there's plenty of good products in terms of LiFTS and other ETFs, other LITs, other structures that can fulfil the same role in portfolio."

For Yap, the key message is that the phaseout is not a threat to income investors, but they still need to be alert to what's happening and seek advice where needed. 

For Martin, the takeaway for investors is that now is the time to educate themselves about the market. 

"Investors owe it to themselves to be reading the great work that Zenith and others put out, understanding what options are out there, and then figuring out what are you going to have in the toolbox to fill the component parts of what your portfolio needs now and what it needs going into the future."

And one silver lining to the hybrids phaseout is that it has left room for innovation. 

"There's the ability for the fixed income market to come and try and replace that for investors," he says. "Whether it be listed notes, whether it be ETFs, I think it probably clears the air a little bit."

"Bank hybrids probably stifled that innovation given how well accepted they were, how large they were and how easy they were to sell. I think there's a bit of pain to go through there and some education, which is key. But ultimately I think we'll be looking at a brighter future."

Challenger IM LiFTS 1 Notes (ASX: CIMHA)

Australian Fixed Income

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