Many managers took the opportunity to add to their holdings as prices collapsed and, due to a belief that CoCos remain an attractive exposure, will keep on buying bank debt. Most CoCos qualify as additional Tier 1 bonds, known as AT1s.
"We are adding to positions in CoCos, but selectively," said Jan Willem de Moor, senior portfolio credit manager at Robeco Institutional Asset Management BV in Rotterdam, Netherlands.
The firm had been overweight the banking sector for some years, although had reduced that a little as spreads recovered. Robeco runs €155 billion ($182.9 billion) in assets.
"But now, with the (recent) CoCo issuance, we think it can be attractive ... as yields everywhere are getting close to zero or negative," while CoCos are offering a coupon of 5% or 6%. "That sounds like a very high number," Mr. de Moor said.
CoCos make up about 5% of eligible strategies. While that's not a huge allocation, "in terms of risk it can be an important part of the portfolio," Mr. de Moor said. CoCos AUM is about €850 million across different strategies.
Amundi executives also bought CoCos after the sell-off, in part because of the type of risk they add to portfolios, said Gregoire Pesques, head of global credit in London. Amundi runs €1.6 trillion in assets with €2 billion of the firm's flagship strategy is run in subordinated debt.
"In terms of opportunities, duration is flat — there's little to no additional incentives to go very long duration at this point in the market. The ideal situation is to go down the rating spectrum to take more credit risk, (but that is) more difficult to access than before in the cycle," he said.
CoCos offer a different type of risk — "subordination risk. Most of the issuers in the subordinated world are investment-grade issuers, very well-known issuers, where the default risk is extremely low," Mr. Pesques said.
"With the normalization we have been adding CoCos," in particular due to government guarantees that have been put in place for new loans in the crisis and also because "there is still a good run for this asset class, so that's the reason why we are — where (able) — long CoCos" and subordinated debt, he said.
BlueBay Asset Management LLP has an off-index allocation in its investment-grade benchmark strategies to AT1s of around 5% to 6%. Multiasset credit strategies, which can invest across fixed-income assets, have about 15% in CoCos, while the $1.2 billion BlueBay Financial Capital Bond Fund is almost exclusively invested in AT1 securities at the moment given the "attractive opportunity in this part of the capital structure.
Allocations were added to in March when valuations got to attractive levels, said Marc Stacey, partner and senior portfolio manager in London. The firm runs more than $60 billion in assets. The firm doesn't split out CoCos AUM.
"Part of the reason why we like banks as a sector is because … banks have spent the last 10-plus years cleaning up their balance sheets, reducing non-performing loans (and they have) also increased the amount of liquidity and market capital they have on their balance sheets. They were entering this economic shock in far better shape than certainly in the last crisis," Mr. Stacey said.
Bank balance sheets are better capitalized too. "This time around, they are the conduit that will really be the transmission regulators (use) to support the real economy. They are going to be part of the solution," he added.
And spreads are attractive. In euro terms AT1 spreads had a pickup of 145 basis points vs. euro-denominated BB-rated bonds as of Aug. 28, while dollar-denominated AT1 bonds were picking up 72 basis points vs. dollar-denominated BB-rated bonds. "This is completely counterintuitive to us, as in an economic shock we're likely to see default rates pick up to a large degree. (That would) impact more cyclical, high-yield names, but the national champion banks that are extremely well-capitalized, profitable, are likely to be far less cyclical and more robust in the wake of what we're experiencing than the market expects," Mr. Stacey said.
He puts it down to markets and investors being "still somewhat scarred by 2007-'08 and when they see the economic drawdowns ... (they) think banks are likely to go the same way."