Shorting European Banks' Riskiest Debt Just Became Much Easier

(Bloomberg) -- Investment funds are making it easier to trade -- and short -- the riskiest type of bank debt, just as the notes’ winning streak comes to end.

Invesco Ltd. is following WisdomTree in rolling out an exchange-traded fund tied to additional Tier 1 notes, the first debt to take losses in a bank crisis. The products will make it easier to trade in a market characterized by high coupons and high volatility, as well as liquidity squeezes at times of market stress.

“Liquidity is key,” said Michael Stewart, regional ETF product developer at Invesco. Many investors trade individual AT1s and they “want an easier way to diversify issuer risk,” he said.

The two AT1 funds come to market as contingent convertible bank notes head for a first-half loss that will end three years of outperformance versus senior bank debt. The notes have crumbled, after market-trouncing returns last year, partly because the looming end of quantitative easing has boosted yields in safer types of debt.

Invesco’s AT1 Capital Bond UCITS ETF, which trades under the ticker AT1 LN in London, tracks the iBoxx USD Contingent Convertible Liquid Developed Market AT1 index. A euro-hedged class will be launched on Thursday. WisdomTree’s AT1 ETF debuted last month.

ETFs ease trading in the generally illiquid bond market as they hold a number of different notes and act as a benchmark for a whole sector. Traders can then quickly buy, sell or short shares from the fund rather than finding someone for a deal tied to a specific bond.

“We expect AT1 LN to attract substantial interest,” Mark Holman, chief executive officer of Twentyfour Asset Management LLP, which oversees about 13.4 billion pounds ($18 billion), wrote in a client note. “We also expect that it will attract some fast money as well as being a vehicle for shorting the sector, so the downside of this development may be some additional volatility.”

European bank CoCos have lost 1.7 percent this year, after returning 7.2 percent last year, according to Bloomberg Barclays indexes. By contrast, senior debt has only lost 0.4 percent this year after returning 1.7 percent in 2017.

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