OREANDA-NEWS. The search for yield and a maturing market for both corporate and financial hybrid instruments in Europe mean only a small number of respondents to Fitch Ratings' latest investor survey have elected to avoid these instruments altogether.

Just 16% of respondents indicated that they were put off by a lack of liquidity and standardisation or by the more binary nature of hybrid risk. The majority - 72% - said they take a "highly selective" approach to hybrid investing depending on the features of the individual instrument, while the remaining 12% said they saw hybrids from any investment grade issuer as generally very attractive due to the extra yield.

The findings support our view of a broadening investor base for both corporate hybrid debt and the additional Tier 1 (AT1) hybrid instruments issued by banks that are designed to absorb losses and would be among the first instruments bailed in in the event of bank resolution.

We have seen a gradual pick up in risk appetite among European corporate hybrid investors over the last couple of years, including a material rise in issuance in the BB category. This has been mostly driven by low-investment-grade utility companies using hybrids to preserve balance-sheet strength amid tough operating conditions and by telecom companies which have used them in part to help fund M&A. The increasing risk appetite is also demonstrated by the presence of a few sub-investment grade issues from more cyclical sectors, including chemicals, airlines and autos.

A combination of lower credit quality and a cyclical market sector increase the risk of a hybrid's equity-like features being activated or of companies being unable to refinance the hybrid instrument at a call date. This is reflected in spreads, with volatility over the last few months from the Greek crisis affecting the hybrid debt of cyclical issuers significantly more than other companies.

AT1 issuance fell in 2Q15 due to a sharp drop in volumes from Chinese issuers, which had been active in the previous six months, as well as the general volatility in Europe during the quarter. Issuance in 2Q15 was therefore concentrated among larger developed-market banks, with spreads looking more attractive thanks to the European Central Bank's quantitative easing program. Coupons are generally between 6% and 8% for major issuers, reflecting both the risk profile and the capital level at which loss-absorption features are triggered.

However, the AT1 market is still not standardised with significant divergence in terms and conditions of instruments. Here the European Banking Authority's efforts to harmonise documentation could have a positive impact by increasing transparency and making it easier for investors to compare instruments.

Fitch's 2Q15 survey represents the views of managers of an estimated EUR7.8trn of fixed-income assets. We will publish the full results later in July. We also recently published our "European Corporate Hybrids Dashboard 1H15," which can be found in the associated research link from this comment, and will publish our latest AT1 Tracker in the next few weeks.