Volatile markets mean defensive allocations are important – but with bank hybrids being phased out, where can investors turn? THOMAS CHOI explores the options
- Bank hybrid phase-out starts next year
- High Grade Floating rate credit offers an alternative
- Find out about Perpetual’s Credit and Fixed Income capabilities
THE phasing out of bank hybrid securities gives investors an opportunity to strengthen the defensive part of their portfolios amid increasing global uncertainty, says Perpetual’s Thomas Choi.
Prudential regulator APRA will begin phasing out the popular securities next year[1], leaving investors in search of a replacement.
Rather than simply seeking the closest replica, Choi says investors now have an opportunity to possibly retain those attractive income benefits while also improving credit quality and reducing their exposure to equity-like risk.
“Perhaps not the most well-understood instrument, bank hybrids were nonetheless broadly adopted by Australian investors and often formed part of the defensive allocation of portfolios,” Choi says.
“But when markets were volatile, hybrids often behave more like equities – they did have significant drawdowns.
“Now, with risk-free rates around the highest level in two decades, you don’t need to move down the credit-quality spectrum or take greater risk for the same sort of income.
“A floating-rate, defensive, high grade credit portfolio is an attractive alternative.”
Why defensive assets matter
Choi says global economic uncertainty and high government spending means investors face a less predictable market environment over coming years, which makes defensive allocations increasingly important.
“Higher inflation, elevated interest rates and larger government debt burdens constrain both monetary and fiscal policy,” he says.
“That means the distribution of potential outcomes is likely to be wider, with a greater probability of tail events.
“In that environment, diversification, liquidity and capital preservation become increasingly important.”
Bond market turmoil
Persistent inflation is limiting central banks’ ability to cut interest rates or use conventional quantitative easing, while elevated government borrowing is putting upwards pressure on bond yields.
That has left policymakers exploring more unconventional interventions, including US Treasury Secretary Scott Bessent’s decision to increase purchases of longer-dated Treasuries[2], potentially funded from government cash balances, alongside the rare use of direct currency-market intervention. While these measures may help alleviate near-term market pressures, greater policy intervention also increases the risk of unintended consequences and market distortions.
As a result, traditional diversification relationships, such as the historically negative correlation between bonds and equities, may become less reliable, with both asset classes potentially experiencing losses at the same time, says Choi.
“For investors, you want to make sure that the defensive part of your portfolio is doing what it's supposed to do,” he says.
“Historically, when equities were down, your bonds were up.
“But that relationship in an elevated inflation environment is not holding.
“That's another reason why high-grade floating rate credit is a really good defensive option.”
Floating rate credit attractive
Choi says the breakdown of the traditional bond-equity relationship means investors need to take a closer look at the duration, credit quality and liquidity of the assets they hold.
Bank hybrids were intended to provide floating-rate income and liquidity in the defensive part of a portfolio – but never really delivered the capital stability investors expected.
Their phase out means investors have an opportunity to move to higher-quality, shorter-duration, floating-rate credit that can fulfil that role.
“High risk-free rates have fundamentally changed the income opportunity available to investors
“Investors may be able to generate attractive income with less exposure to interest-rate volatility.
“A defensive and liquid allocation can provide income and capital stability through periods of volatility, while preserving the flexibility to redeploy capital when markets dislocate.
“That doesn’t mean bonds have lost their defensive role. But it does mean investors need to think more carefully about the type of fixed income they own. Duration, credit quality and liquidity all matter.
“Investors often think of fixed income as interest-rate duration.
“But you don’t have to take interest-rate risk when you buy fixed income.”
Find out more about Perpetual High Grade Floating Rate Fund, which was recently named a winner in the Australian Fixed Income category at the 2026 Financial Newswire/SQM Research Fund Manager of the Year awards.
[1] APRA finalises changes to phase out Additional Tier 1 capital instruments | APRA
[2] Treasury Announces Increased Sizes of Nominal Long-End Liquidity Support Buybacks Beginning September 9 | U.S. Department of the Treasury
About Thomas Choi and Perpetual’s Credit and Fixed Income team
Thomas is a senior portfolio manager with Perpetual’s respected Credit & Fixed Income team.
He focuses on the management of the treasury portfolios.
Thomas has more than 20 years of investing experience and has worked with us since 2010. He has a Bachelor of Economics from Sydney University and is a Chartered Financial Analyst.
Perpetual offers a range of cash, credit and fixed-income solutions. We are specialists in investing in quality debt.
We take a highly active approach to buying and selling credit and fixed income securities and invest extensively across industries, maturities and the capital structure.
Find out more about Perpetual’s Credit and Fixed Income capabilities
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