Q. I have received an offer to buy ComBank PERLS VIII Capital Notes following the maturity of my investment in PERLS III.  With interest rates available on Term deposits heading south of 3%, should I consider taking up the offer?

A. CBA PERLS VIII Capital Notes are a form of Hybrid investment issued by the Commonwealth Bank of Australia (CBA) to CBA shareholders, holders of existing PERLS III notes and those with a broker participating in the book build. The CBA intend to raise $1.25 billion but with the flexibility to extend the offer if oversubscribed.

Hybrid investments are securities that have debt and equity like features. Generally they offer a quarterly coupon (interest) payment and potential for conversion to the underlying issuers shares at a predetermined time, at the discretion of the issuer.

The attraction of hybrids is that they often will pay a higher coupon (interest rate)  than conventional fixed interest investments such as Term Deposits.  In the case of PERLS VIII, the coupon return will be in the range of 5.2% + the Bank Bill Swap rate (BBSW). So the anticipated rate of return will be around 7.5% (including franking credits).

Note the BBSW is the interbank interest rate charged by financial institutions for interbank trade.  Often referred to as the banking wholesale interest rate, it is used as a benchmark rate for financial investments.  The current BBSW is roughly 2.3%.

The problem with hybrid securities is that they are not Term deposits and are priced in the market based on the supply of notes for sale and the demand for said notes.  The investor is taking on a variety of equity like risks with Hybrids which they would not be taking on through investing in a Term Deposit.

The risk with a Term deposit is the bank being solvent through the term of the investment. Whilst Term Deposits can be cashed with the bank at full face value albeit with a penalty on interest, hybrids need to be sold on market and the price could vary dramatically from the face value. Investors in CBA Perl VII, a $3 billion raising in 2014 have never seen the value of their notes trade near their $100 face value. The current bid price on the notes is  $86.52.  So ignoring the coupon rate on PERLS III of 2.8-3% over BBSW, recent experience has not been a happy on for those looking to sell prior to their maturity or conversion date.

An alternative to buying a new hybrid  issue would be entering the market and buying older issues that are trading at a discount to their face value.  Combining the discount to the face value, the coupon rate and the time to maturity, the aggregate return in some cases is commensurate if not higher than the new offer by CBA.

Whilst Hybrids are often marketed as fixed interest investments, they are complex in nature and carry risks often not easily understood. So be careful and know what you are buying.

The decision whether to invest in either Term Deposits or Hybrids will be based on your time frame to invest, the issuer’s credit worthiness, the structure of the note and your appetite and capacity to absorb the above mentioned risks.

CBA PERLS VIII Capital Notes offer closes on 18 March.

Follow Andrew on Twitter @AndrewHeavenFP. This article was originally published in The Australian