State Street ETF development to capitalise on AT1 exit

With a year left until the start of the AT1 hybrids phase out, State Street Investment Management head of intermediary, Australia, Tim Bradbury said advisers are looking for high yield solutions to take their place in client portfolios.

As of 1 January 2027, AT1s – also known as hybrid bonds – will start being phased out following Australian Prudential Regulation Authority (APRA) concerns regarding the reliability and complexity of hybrids in a future crisis.  

This is because they carry greater credit risk than corporate bonds due to their subordinated status in the capital structure.

While the full phase-out will not be complete until 2032, investors and advisers are already beginning to shift assets in other types of bond vehicles.  

Speaking to Money Management, Bradbury said: “For example, the Australian high income ETF that we have, it's been really good year, that's been gathering good flows off the back of this search for yield, and you've probably seen that generally in the market, particularly as the theme around hybrids rolling off continues for the next two or three years.”

As this progresses, advisers will be looking for the right type of asset to fill the gap in client portfolios, he said, particularly those with older clients who will be eyeing higher yield opportunities as they move into the pension phase.

For those looking to high yield solutions, Bradbury said advisers and investors tend to lean more towards Australian government and corporate bonds, suggesting that State Street will be looking to grow its presence in this sector.

“We took the chance in the middle of the year to refresh one of the key indexes we have, which makes that exposure largely 50/50 between Australian government bond and corporate bonds,” he said.

“So, we like the corporate bond exposure because it gives you a higher running yield and it does dampen down some of the drawdown impact, and we think that's a trend that we're seeing in the ETF market as well.”

Looking to capitalise on this opportunity, Bradbury said that State Street intends to introduce new offerings in the high yield space next year, with other providers also expected to do so.

“Around yield and high income, you're going to see more products partly around the displacement of the of the role of hybrids, but you'll see products from us in that space as well into the new year, and not just from us.”

Although there is some uncertainty about if the RBA will hold or even rise following recent CPI data, Bradbury said that when rates drop, this will fuel even stronger demand for high-quality yield and income solutions in the ETF markets.

However, others have suggested advisers might look elsewhere for a replacement. Speaking with Money Management earlier this year, Viola Private Wealth’s chief investment officer, Daniel Kelly, suggested that Tier 2 instruments will become the “highest-yielding part of a domestic bank’s capital stack” triggering a significant inflow into that sector.

At the same time, Kelly said that advisers should be focusing on what role the hybrids’ have played in the client portfolio and look for something that meets that need and goal, rather than simply seeking an alternative to the hybrid itself.

With this search for a replacement is expected to accelerate next year, it has already seen flows into cash and fixed income ETFs grow in recent months. Citing the move away from AT1 hybrids as the key driver, Betashares monthly report revealed there was a 46 per cent rise in flows to cash and fixed income ETFs in October, hitting $1.79 billion.

Meanwhile, monthly commentary from Global X ETFs found that Australian credit ETFs continued to be a key focus for inflows in the wake of hybrid securities rolling off with the sector seeing the highest-ever monthly inflows of $526 million.

Some providers have already jumped on this opportunity this year, with VanEck announcing earlier this week that it will launch the VanEck Australian Fixed Rate Subordinated Debt ETF (FSUB), offering fixed-rate exposure which will enable investors to access attractive nominal yields and diversify their rate exposure.

Then just last week, Betashares unveiled its Enhanced Credit Income Complex ETF (ECRD) with the aim of providing investors with a higher level of income than traditional bond funds and hybrids, while maintaining a volatility profile similar to hybrids.

These mark the latest of many fixed income ETFs launched this year, with even more likely to hit the market in 2026.