When it comes to the phase-out of AT1 bonds, Schroders fixed income manager Helen Mason has urged financial advisers to sell up sooner rather than later or risk capital losses.
Prudential regulator, Australian Prudential Regulation Authority (APRA), announced at the end of last year that AT1s – also known as hybrid bonds – will be phased out in 2027, as the regulator was concerned about their reliability and complexity in a future crisis. This is because they carry greater credit risk than corporate bonds due to their subordinated status in the capital structure.
They were a popular asset for retail investors for their perceived safety and their franking credits, which presented an attractive yield in the post-GFC years, and returns were low.
However, Schroders portfolio manager, Mason, said she believes they are riskier than retail investors may think, as they trade like equities rather than bonds and have a higher risk of loss than term deposits.
Speaking to Money Management, Mason, who is manager of the $911 million Australian High Yielding Credit fund, said: “If you think about the post-GFC years, you had low very interest rates, very low volatility and it was really hard to make money. So hybrids were a great alternative in this environment to receive income on your portfolios.
“People didn’t care what was in it, they couldn’t hold 100 per cent in equity so they diversified into other asset classes which were AT1s.”
She welcomed APRA’s phase-out of the offering, noting Australia is currently the only country that allows retail investors to access the product in the first place, while other countries allow them to be used only by wholesale ones.
Now, with hybrids already starting to be called, she has urged those holding the assets to sell up rather than wait. Just over three-quarters of the current hybrid securities available will be called in the next five years.
“Every single retail hybrid security is currently trading above par. It is important to remember if investors wait until the call date, they will not receive the current trading price, which could be $106, as the price will pull towards the par value of $100 as these securities get closer to call,” she said.
“Investors should therefore start considering other options to replace their hybrid exposure while the price remains high and to avoid the potential for capital losses into the future.”
Instead of AT1s, Mason suggested looking at public debt, which can provide an element of diversification, as around 60 per cent of issuance is unlisted, so investors would be unable to access it via the equity markets. ETFs investing in subordinated debt are also another option, and ETF providers have previously discussed with Money Management how this is factoring into their future product development plans.
One area where she was cautious of advisers and retail investors rotating into is private credit, a popular asset class currently, but one where she believes the risk is not worth the return.
“You’re not getting paid to take the risk anymore, when you were getting 14-16 per cent then you were paid for the risk but now yields are the same as public credit markets, it doesn’t make sense to take such high risk for such low return,” she said.
