Citigroup Inc. Headquarters in New York, U.S. (Photographer: Daniel Acker/Bloomberg)

Citi, Goldman Are Said to Plan ETFs Tied to Riskiest Bank Bonds

(Bloomberg) -- Citigroup Inc. and Goldman Sachs Group Inc. are among firms seeking to set up exchange-traded funds tracking the riskiest European bank bonds, according to people familiar with the matter.

Citi met with investors this year to promote an ETF that will track an index of additional Tier 1 notes, said the people, who asked not to be identified because the information isn’t public. Goldman is working with an issuer to offer a similar product, while China Post Global, the international asset-management unit of China Post & Capital Fund Management Co., is also preparing an AT1 fund, the people said.

Officials at Citi and Goldman declined to comment on whether they were planning AT1 ETFs. Danny Dolan, a London-based managing director at China Post Global, which acquired the European ETF business of Royal Bank of Scotland Group Plc in 2016, declined to comment on the firm’s plans.

ETFs linked to AT1 bonds will broaden access to one of the best-performing and highest-yielding asset classes of the past year. In 2017, the notes rewarded investors with a 14 percent gain, according to the ICE BofAML Contingent Capital Index, about twice the return on high-yield corporate bonds.

Broader Audience

That could be a problem, according to Philippe Kellerhals, a portfolio manager at Cairn Capital, which oversees $3.4 billion. A broader audience may mean more retail investors who can be more skittish than their institutional counterparts, raising the possibility of higher volatility.

“The big difference is that ETFs are listed, so the investors getting involved may be different,” he said. “The risk is that when sentiment changes, the ETFs could accelerate price volatility.”

AT1s were created after the financial crisis to bolster banks’ financial reserves and are first in line to take losses if the issuer runs into trouble.

The risk associated with AT1s was highlighted last year, when Banco Popular Espanol SA was absorbed by Banco Santander SA and junior bondholders lost their money. Issuing banks also have the right to suspend coupons on the bonds, extend the repayment date indefinitely or write them off entirely.

Meanwhile, ETFs were also swept up in the recent bout of financial-market turbulence with investors withdrawing a net $31.7 billion from the products last week, compared with $10.4 billion in the previous period, according to data compiled by Bloomberg.

Investors can already bet on the AT1 market without handling the underlying notes. Last year Goldman Sachs and JPMorgan Chase & Co. started making markets in total-return swaps. The derivatives also allow clients to bet against AT1s or hedge their existing positions.

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