Corporate Hybrid Bonds offer a compelling diversification opportunity. Unlike CoCos, Hybrids exhibit lower volatility, stronger incentives for first-call redemption, and cash-cumulative coupon deferral, making them a more stable and liquid option. With imperfect correlation to CoCos, hybrids can further enhance portfolio resilience, especially amid market disruptions.
Corporate Hybrid Bonds vs Contingent Convertible
Bonds – Absolute Spread Differential
Data: Neuberger Berman, Bloomberg; as of 15 April 2025.
- The Corporate Hybrids (“CH”) to Contingent Convertible (“CoCo”) absolute z-spread differential has narrowed, and has been trading tighter than the long-term (10 years) average of 100 basis points since 2024 to date, partially due to CoCos’ higher beta nature in an up market. However, CoCo’s higher likelihood of extension could see this spread basis widen again, presenting good relative value in Corporate Hybrids.
- For example, we saw CoCos spread shot up in both 2020, during covid outbreak and 2023, Credit Suisse event, which widened the basis to Corporate Hybrids.
- From a portfolio diversification perspective, Corporate Hybrids can provide both risk reduction and return enhancement to portfolios holding traditional Investment Grade and High Yield credits.
- Corporate Hybrids also has an imperfect correlation to CoCos, adding diversification benefits to portfolios with existing CoCo exposures.
Are Corporate Hybrid Bonds like “CoCos” or banks’ “Additional Tier 1” bonds?
Like the “Additional Tier-1 Capital” (AT1) or Contingent Convertible (“CoCo”) instruments issued by banks, Corporate Hybrids are long-dated, callable, subordinated and pay deferrable coupons.
However, we believe the differences are more important:
- Corporate Hybrids have strong incentives to call at the first call date given the loss of favorable rating agency treatment after the first call date—not the case for CoCos.
- In the event of a deferral, coupons for a corporate hybrid would be cash-cumulative and compounding—not the case for CoCos.
- No regulator can intervene to prevent hybrid coupon payments or force their conversion to equity, as they can for CoCos.
- Corporate hybrids are included in the major fixed income indices, allowing for added liquidity, and tend to trade with a materially lower volatility relative to CoCos.
- Reflecting these differences, corporate hybrids are rated one or two notches below the corporate issuer’s rating, whereas CoCos are typically rated three notches lower.
