Using ETFs to better access AT1 bond markets

Published on 23 November 2021

The AT1 bond has a very global market, reflective of the investor types who wish to use these bank-issued convertible instruments. However, as they are particularly sensitive to US Treasury movement as a result of their call and reset features which are based on futures rate moves, trading in them can be challenging in the current environment.

Invesco’s AT1 Bond Exchange Traded Fund captures the USD denominated bonds, with over 80 issuances targeting the most liquid bonds, so investors can benefit from subordination and a 350 basis point Z spread.

Deepak Bharti and Rob Simnick from Invesco discuss how investors are using this instrument to trade into the AT1 market most effectively.

Dan Barnes: Welcome to Trader TV – your insight into trading for professional investors. I’m Dan Barnes, and joining me today on Deepak Bharti, Senior Portfolio Manager at Invesco, and Rob Simnick, Senior Investment Trader as Invesco.

And we’re going to discuss the AT1 bond market and the challenges in liquidity and price formation due to the concentrated nature it has and the advantages of using an exchange traded fund to access the market.

Deepak, Rob. Welcome to the show.

Deepak Bharti: Thanks, John.

Rob Simnick: Hey, Dan, thanks for having us.

Dan Barnes: So first of all, what are AT1 bonds and what are investment managers actually using them for?

Deepak Bharti: AT1 bonds are a special type of ‘coco’ bonds (Contingent Convertibles), which essentially are hybrids. They have a Basel III requirement to be at point of assurance designated as additional tier one bonds. In short, hybrid bonds, which are contingent convertibles aka ‘cocos’.

Rob Simnick: Investors tend to be more income seeking mutual funds, hedge funds, private banks, insurance funds are not typically involved in the AT1s due to their greater risk nature with US Treasuries and the lack of defined flows and maturities. We see a lot of Asian accounts that are restricted and preferred, so they’ll go after AT1s ones. It’s a much more global market with a larger account customer breath and then some other products.

Dan Barnes: Very good. And then how are liquidity, price formation and volume in the cash bond market for AT1s?

Rob Simnick: It’s about a billion a day in AT1s vs IG Corp’s overall, which is 20 billion. From a dealer standpoint, you know, the books are often shared between the London and the US market making desks. Some dealers stop trading the product on the European close, so for us in the US, it’s always busy the first two hours in the morning and then it’ll die off.

Dan Barnes: How does the ETF work and was it capture?

Deepak Bharti: Our ETF, AT1 LN is the largest AT1 ETF available in the market. It captures the US denominated ‘coco’ bonds that captures over 80 issuances and 22 issuers. But we target the most liquid bonds, so the issuer size is important. The total issuance by issuer should be over $1 billion. Each individual issuance should be over 715 million. The issuer rating would be around A negative, whereas the issuances rating would be BB+. So the benefit that the investors are getting is purely from the subordination and the spread. We are talking about guarantees around 350 basis points that investors can capture.

Dan Barnes: And then what are the challenges in investing and trading in the AT1 market?

Rob Simnick: AT1 is almost always a call features and resets based on futures rate moves. These, combined with the yield and dollar price, makes them particularly sensitive to the US Treasury movement, so it’s a challenging time for that market right now.

Dan Barnes: OK. And how does the ETF support trading and investment management?

Deepak Bharti: On the ETF side, in the process of creation redemption, it could be cash or bonds, or just creation redemption process, which really helps the market provide an additional layer of liquidity. In general, the market makers and the authorized participants have sufficient liquidity. Even in the turmoil last year, we did not see significant issues managing or trading the AT1 ETF.

Dan Barnes: Are there any barriers for investment managers or traders who might want to trade ETFs today?

Rob Simnick: Because it is a smaller subset of traders that are focused on it, that provides its own set of challenges. But although it’s a small set of eyes, they’re very sharp and they’re on the market all the time. One of the things that we do here at Invesco is we’re really good at collecting that market beta, collecting those bids and those asks in that market color. And what I find is the AT1 product has a much more complete set of data, because you have those traders that are very focused on it. So when we go and collect that information we can paint a clearer picture of how to trade it than other larger products.

Deepak Bharti: What Rob mentioned was more from the bond perspective. From an ETF perspective, we have some solid market makers and authorized participants who maintain and manage liquidity. Contrary to if we were talking about the investment grade ETF, whereby most of the creation are in kind, in AT1 market creation redemption, we do see a fair amount of 50/50, I would say, in kind vs cash creations. And thanks to Rob, our executions have been pretty impressive to support the creation redemption process so far.

Dan Barnes: So how important is the role of trading in supporting the investment management process in delivering this product?

Deepak Bharti: It’s absolutely critical. In particular AT1s are traded out of the US and some part of it that’s traded in Europe, but it’s absolutely critical for trading to be able to support that product. Otherwise, to navigate the illiquidity in this market would be very challenging.

Rob Simnick: The approach we take is multifaceted. Depending upon the size, you’re going directly to a trader and talking about a trade negotiating price. In the case of, you know, larger flows that are more spread out over more bonds, which is often the case for our ETF product, sometimes we use, you know, electronic feedback using one of the more common trading platforms that you see out there.

But the third way that we’ve been doing it, which is new and not very common, especially for this product, is we’ve been successfully doing portfolio trades for the ETF, and that’s worked out very well. I would say it continues to be one of our competitive advantages as a firm and for our AT1 ETF.

Dan Barnes: That’s excellent. Guys, thank you so much. That’s really interesting.

Deepak Bharti: Thanks, Dan.

Rob Simnick: Thanks, Dan. Thanks for having us.

Dan Barnes: I’d like to thank Rob and Deepak for their insights today, and of course, you for watching. To catch up on our other shows or to subscribe to our newsletter go to TRADERTV.NET.