(Bloomberg) -- The start to the Federal Reserve’s interest-rate cutting cycle has fueled optimism for a long-sought wave of investor money in credit’s best-performing market.
Additional Tier 1 bonds, the riskiest type of bank debt, have been struggling to attract flows despite delivering double-digit returns this year. The Fed’s half-point cut on Wednesday is now seen as a potential catalyst that will jolt investors into finding riskier alternatives to the diminishing returns from cash.
“Some investors were on the sideline,” said Raphael Stern, global head of fixed income at Invesco Asset Management Ltd who runs the biggest AT1 exchange-traded fund. “AT1s is a yield product without much duration, positioned nicely for a lower yield and curve-steepening period,” he said.
AT1 bonds issued by European banks have returned 10.5% in US dollar terms this year, which is more than double the gains in global high-grade bonds and about three percentage points above junk bonds, according to data compiled by Bloomberg.
Created after the global financial crisis to provide capital buffer for lenders, the asset class was shaken in 2023 by the writedown of Credit Suisse notes as part of a government-backed takeover by UBS Group AG. This year, however, has seen an outperformance on the back of high yields and the perceived safety of issuers.
AT1s are typically incorporated by investors into broader portfolios or funds investing in bank capital, which renders the calculations of flows an inexact science.
Invesco’s ETF — serving as a proxy — has seen its assets shrunk by more than $100 million to about $1.05 billion this year, according to data compiled by Bloomberg. This is despite the fact that the ETF has posted total returns of nearly 10% in 2024.
“Flows haven’t really caught up,” Barclays Plc analysts including Soumya Sarkar wrote in summary notes of a credit forum held earlier this month in New York. “There was an expectation of higher inflows into the asset class once the Fed starts its rate-cutting cycle.”
Money-market funds have been a major beneficiary of central banks jacking up rates to tackle inflation over the past few years, offering high returns while bonds printed historic losses as their coupons were deemed inadequate.
The start of a global monetary-policy easing cycle is set to reverse this trend.
“As we come off very high rates in the context of the last 10 to 15 years, one would probably expect a more pronounced response in terms of asset allocation away from money markets and into credit funds,” said Jakub Lichwa, a portfolio manager at TwentyFour Asset Management.
Some money managers had been flagging AT1s as a leveraged play on rate cuts at the start of the year, but investors have been slow to respond.
“It is true that we have not seen the inflows we were expecting,” said Invesco’s Stern. “The trade would’ve been good.”
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