Invesco Launches Sterling and Dollar-Hedged ETF Share Classes for European AT1 Bank Bonds

Invesco has listed two new exchange-traded funds (ETFs) on the London Stock Exchange, providing investors with currency-hedged access to a specific and higher-yielding segment of the European bank debt market.

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By ETFWorld.co.uk

Gary Buxton, Head of Product, EMEA di Invesco

The funds track Additional Tier 1 (AT1) contingent convertible bonds, commonly called CoCo bonds, issued by banks in developed markets.

The newly listed share classes are:

• Invesco EUR AT1 CoCo Bond UCITS ETF GBP Hdg Dist (ISIN: IE0006WZF7C2)

• Invesco EUR AT1 CoCo Bond UCITS ETF USD Hdg Acc (ISIN: IE000WQJ37B1)

Both ETFs will track the same underlying index, the iBoxx EUR Contingent Convertible Liquid Developed Markets AT1 (8% Issuer Cap) Index, and carry a Total Expense Ratio (TER) of 0.39% per annum. The key difference between them is the currency of the share class and its income treatment: the GBP-hedged version distributes income quarterly, while the USD-hedged version accumulates it.

ETF Specifications and Strategy

The new ETFs aim to replicate the performance of their reference index through full physical replication, meaning they will buy and hold the constituent bonds where possible. The index itself comprises euro-denominated AT1 bonds issued by banks from developed market countries. To be included, bonds must have a minimum credit rating of ‘B’ and a minimum outstanding volume of €500 million. The index also applies screening so that all issuers must comply with the United Nations Global Compact principles.

A central feature of these products is their currency-hedged share class structure. While the underlying bonds are denominated in euros, the ETFs will engage in foreign exchange transactions to minimise the returns impact of fluctuations between the euro and either the British pound (for the GBP Hdg Dist share class) or the US dollar (for the USD Hdg Acc share class). This structure is designed for investors who want exposure to the asset class but wish to mitigate the specific risk of euro currency movements.

Understanding the Underlying Asset: AT1 CoCo Bonds

AT1 bonds are a specialised type of bank capital created after the 2008 financial crisis as part of the Basel III regulatory framework. They are hybrid instruments that sit between equity and debt in a bank’s capital structure and are designed to absorb losses if the bank runs into severe financial difficulty.

Key characteristics that define their risk and return profile include:

• Contingent Convertibility/Loss Absorption: If a bank’s capital levels fall below a predetermined threshold, these bonds can be automatically converted into equity or their face value can be written down permanently to recapitalise the bank. This mechanism was activated prominently during the 2023 rescue of Credit Suisse, where certain AT1 bondholders suffered total losses.

• Perpetual Nature with Call Options: AT1 bonds typically have no fixed maturity date. Instead, issuers embed a call option, often after 5-7 years, allowing them to repay the bond at face value if they choose.

• Discretionary Coupons: Banks can typically cancel coupon payments without defaulting, often a requirement if their capital levels deteriorate.

• Higher Yield: To compensate investors for these complex risks—including subordination, loss absorption, and coupon cancellability—AT1 bonds offer higher yields than senior bank debt.

Considerations for Investors

The launch of these ETFs offers a more accessible route to a complex asset class. However, the specific risks of AT1 bonds demand careful consideration.

• Primary Risk: The loss-absorption mechanism means investors can suffer a total or partial write-down of their principal, which is senior to equity in a crisis scenario.

• Interest Rate Risk: Like all fixed income, bond prices are susceptible to changes in interest rates.

• Credit Risk: The fund holds bonds from the banking sector, making it sensitive to the financial health of European banks.

• Liquidity Risk: The underlying AT1 bond market can experience periods of low liquidity, which may impact trading.

These products are likely aimed at institutional investors and sophisticated retail investors who understand the risks and are seeking higher yield potential within a diversified portfolio. The currency-hedged share classes specifically target those who want to isolate the credit and yield characteristics of the bonds from direct euro exchange rate movements.

The addition of these ETFs provides the LSE-listed market with a new, cost-competitive option for gaining exposure to European bank capital bonds, filling a specific gap for investors seeking currency-hedged solutions in this segment.

Source: ETFWorld.co.uk