Julian Marks, Head of Hybrid Bonds, Nomura Asset Management U.K. Ltd writes that defined contribution (DC) pension schemes in the UK continue to face a difficult balancing act: generating sustainable income in a low-yield world while meeting increasing expectations around governance, diversification, and ESG alignment. In this environment, trustees and their advisers are rightly exploring new corners of the fixed income universe.
One area that deserves attention, but remains under-utilised in many portfolios, is the corporate hybrid bond market.
Corporate hybrids – subordinated debt instruments issued by non-financial, investment-grade corporates – have quietly matured into a liquid, transparent, and structurally significant asset class. While hybrids sit between senior debt and equity in the capital structure, and may at first glance appear complex, their growth trajectory and market evolution tell a compelling story for long-term investors.
Since the formalisation of corporate hybrid methodologies by the credit rating agencies in 2012, the market has expanded rapidly. It now exceeds USD310 billion globally, having more than doubled in size over the past decade. Importantly, this expansion has not been driven solely by investor demand for yield, but by corporate treasurers looking for an efficient way to raise capital without jeopardising credit ratings or resorting to shareholder dilution.
Corporate hybrids receive partial equity credit from rating agencies – typically 50 per cent – allowing corporates to optimise their balance sheets while preserving investment-grade ratings. This makes them particularly attractive for capital-intensive issuers such as utilities, telecoms, and infrastructure businesses, many of which are also engaged in multi-decade energy transition plans. As a result, corporate hybrids have increasingly become a tool for funding large-scale ESG-linked investments. The US market, historically underrepresented in this space, is now catching up. Moody’s recently increased its equity credit treatment for hybrids issued by US corporates, leading to a new wave of issuance that could add over USD100 billion in coming years.
This maturing market presents an attractive proposition for DC pension schemes. At the portfolio level, hybrids offer yields significantly above traditional investment-grade credit – often in the range of 5 to 7 per cent – while maintaining exposure to issuers rated A to BBB. In a world where high-yield bonds and equities often carry much greater downside risk or volatility, corporate hybrids represent a middle ground: more income, but from stronger names.
The structure of hybrid bonds involve some nuances, but they are investor-friendly. Most corporate hybrids are long-dated or perpetual but include call dates – typically after five to ten years – where issuers are strongly incentivised to redeem. Coupon step-ups, loss of equity credit, and the reputational consequences of non-call behaviour all encourage timely redemption. Similarly, while coupons are technically deferrable, no investment-grade issuer has ever exercised that option. Deferring coupons would mean dividends and all other shareholder returns would need to cease. The universe of issuers here has been paying dividends for decades, including through the Global Financial Crisis, Eurozone Crisis and Covid. In addition, all corporate hybrids feature cumulative provisions, meaning any deferred payments must eventually be repaid.
For trustees, this means the perceived risks around extension and deferral are far less significant in practice than on paper. Moreover, the effective duration of hybrids is typically around three and a half years, owing to call expectations. As such, they can slot into portfolios without creating undue interest rate sensitivity and may even help buffer other fixed income allocations during periods of rate volatility.
Implementation is also improving. Specialist funds are now available to access this segment through diversified, actively managed portfolios. Nomura, for instance, launched its Corporate Hybrid Bond Fund in August 2023, with assets of over USD500 million as of mid-August 2025. The fund typically holds 35-40 issuers across multiple sectors and geographies, with full currency hedging and a clear ESG policy. It excludes controversial industries and issuers in breach of global norms and evaluates decarbonisation efforts as part of its credit analysis – fitting for schemes seeking Article 8 or responsible investment alignment.
From a governance perspective, trustees considering corporate hybrids should ensure that scheme documentation permits investment in subordinated credit instruments and that such exposures are aligned with the scheme’s Statement of Investment Principles and broader investment beliefs. They should also consult their investment consultants to assess how hybrids could sit within the default strategy – whether in a dedicated credit allocation, a multi-asset income fund, or as a complement to diversified growth strategies.
For most schemes, a modest allocation – perhaps 3 to 5 per cent within the return-seeking or credit sleeve – could offer enhanced yield and diversification without fundamentally altering the scheme’s risk profile. As with any investment, manager selection, portfolio construction, and liquidity considerations are crucial, particularly given that hybrid bonds tend to trade in larger sizes and require active monitoring of call behaviours and credit quality.
In conclusion, corporate hybrids are no longer a marginal or opaque market. They are a fast-growing and increasingly mainstream asset class, offering attractive yields, strong credit fundamentals, and a clear rationale for inclusion within a diversified DC investment strategy. For trustees facing the dual pressures of performance and responsibility, corporate hybrids offer a timely and credible solution worth bringing to the table.
