Investors piled into a contingent convertible (CoCo) bond ETF last week, a sign they are looking to more esoteric parts of the fixed income market for yield.
Tracking the Markit iBoxx USD Contingent Convertible Liquid Developed Markt AT1 (8/5% Issuer Cap) index, AT1 offers exposure to European banks’ CoCo debt. CoCo bonds are the riskiest debt issued by major European banks such as the Royal Bank of Scotland, Lloyds and UniCredit.
Yielding around 5%, AT1 currently has 30.1% exposure to UK issuers, 17.7% to French issuers and 15.6% to Swiss issuers.
The inflows come at a time when regulators are very keen to ensure European banks are well supported following the coronavirus pandemic.
The European Central Bank (ECB) on 27 July once again told European banks to freeze dividends, this time until the end of the year in order to shore up capital.
Andrea Enria, chairman of the ECB supervisory board, said in a statement: “It is all the more important to encourage banks to use their capital and liquidity buffers now to continue focusing on this overarching task: lending, whilst of course maintaining sound underwriting standards.”
Matthew Tagliani, head of product and sales strategy, EMEA, at Invesco, said the perception from investors is the level of regulator intervention has created an environment where a write down in AT1s is “very unlikely”.
With many investors calling a V-shaped recovery in markets, CoCo bonds offer an attractive way to capture the rebound in asset prices, especially with government and investment grade yields trading at very low levels.
Furthermore, the inflows come in the same week when investors pulled assets from high yield ETFs suggesting a rotation. For example, the €6.7bn iShares € High Yield Corp Bond UCITS ETF (IHYG) saw $164m outflows, the fifth highest across all European-listed ETFs.
There has been an increase in high yield default rates, especially in the US, where they have reached 5.1% in the oil and retail sectors, according to Fitch Ratings.
As Athanasios Psarofagis, ETF analyst at Bloomberg, said: “Investors are looking at [AT1] as an alternative to high yield. It is probably a better risk to yield trade-off right now.”