Self-managed super fund trustees looking for stable income-generating investments outside of term deposits would be interested to learn that ANZ will soon issue some new ‘convertible preference shares’.

The convertible preference shares behave like an income security in that the income return ‘floats’ relative to an industry market benchmark. The distributions are paid as ‘fully franked’ dividends, which makes the shares a tax-effective alternative to term deposits or other cash-based investments for an SMSF.

The issue – CPS3 – is ANZ’s third issue of this type of security following CPS1 and CPS2, which are both listed on the ASX and trade under the stock codes ANZPB and ANZPA, respectively. The latest issue will open for subscription this Wednesday and closes 27 September. It will trade on the ASX as ANZPC.

The key details are:

 Before comparing this investment with a term deposit, let’s take a quick look at the dividend payment.

ANZ will calculate the floating dividend at the start of every half year. This is done by taking the benchmark interest rate – the six-month bank bill rate (which is the interest rate at which banks lend to their best corporate customers) – and adding a margin, which, in this case is 3.1%. An adjustment is then made to account for the company tax rate because the dividend is to be fully franked. The end result is the dividend that is paid to investors for that half-year period.

To illustrate how this works, let’s compare two investments of $10,000: a six-month term deposit paying interest at 5.6% per annum; and an investment in ANZ’s CPS3. Let’s assume the six-month bank bill rate is 4.69%.

As the table shows, an SMSF in accumulation phase (paying 15% tax on investment earnings), will have an after-tax return of 6.62% from CPS3 compared with 4.76% for the term deposit. In pension phase (see table below), CPS3 yields 7.79%pa after tax compared with 5.60% for the term deposit.

Of course, these returns will vary as the underlying six-month bank bill rate moves up or down with the market – what’s important here is the attractive differential to the alternate investment in a six-month term deposit.

So, what are the risks?

Most importantly, ANZ’s CPS3 is not a bank deposit and is therefore not eligible for the government’s deposit guarantee. The security also ranks behind all depositors and creditors of the bank. Dividends might not be paid in very defined and limited circumstances, and because the issue qualifies as ‘capital’ for the bank, mandatory conversion or early redemption can only occur if the Australian Prudential Regulation Authority (APRA) gives its consent. All these details are set out in the CPS3 prospectus.

Moreover, ANZ’s CPS3 securities will be listed on the ASX. This should provide investors with easy liquidity, but it also means the securities’ trading price will ultimately reflect supply and demand considerations, as well as the market’s view of the ‘margin’ for comparable securities or new issues.

If this issue is successful – which we expect it to be – it’s quite likely that other major banks will follow with similar style issues, so you might want to keep some powder dry.

The CPS3 issue is certainly worth looking at for your SMSF. As always, potential investors should carefully review the prospectus before deciding to invest. Many stockbrokers or financial advisers can offer a ‘broker firm offer’ and existing ANZ shareholders will be afforded priority over the general public.

Disclosure: The author and/or his SMSF own ANZ Ordinary Shares and ANZPA, and intends to apply for ANZ CPS3.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Also in today’s Switzer Super Report

• Peter Switzer: What I’m watching in the coming weeks
• Tony Negline: The six key reasons SMSFs butt heads with the law
• Roger Montgomery: My analysis of Matrix Composites and Engineering