Investing in AT-1 Bonds

[cvs]

@iamshrimohan

who will susbcribe for this? The G-Secs are giving 7.5% around.
Who would risk the capital for 0.75% extra gain?

@cvs

Why bother with all the risks associated with an AT-1 bond ?
If one already has a couple of crores invested in GSECs,
and can afford to risk occasionally losing dividend-returns or even the principal itself,
then can take a chance with 1-2 lots (10-20lacs worth) of such corporate PSU / NBFC AT-1 bonds, maybe?

Folks with crores of investments, can risk a few 10s of lakhs.
Such folks are also likely to invest over a wide spectrum of risk v returns.

_{A Brave New Life - A 6-part series on Financial Freedom}

Another aspect to consider would be diversification and hedging.
Diversifying one’s investments into inversely correlated instruments can reduce overall risk by hedging.

Someone is maybe already invested (or is planning to invest) in some other instrument which is

• tending to depreciate slightly under the current scenario
• and stands to gain 10x in some alternate scenario
  that also happens to be a “worst-case” scenario for SBI
  (in which it faces extreme financial stress and will default on its AT-1 bonds).

For such an investor, investing in SBI AT-1 bond + their other investment,
would actually end-up lowering their overall risk.

Having invested appropriate sums in both,
even in the worst-case scenario for SBI AT-1 bonds,
their other investments will more than make-up for their loss of principal in these SBI AT-1 bonds.
(and until that worst-case happens, they get to earn >9% interest on these SBI AT-1 bonds each year )

So, one of the “ideal scenarios” for the above investor would be that

• the worst-case scenario for SBI AT-1 bonds does NOT occur
• i.e. their other investments that could have 10x-ed in such a scenario also doesn’t happen.
• and their total returns would include
  • >9% (from SBI AT-1 bonds)
  • and whatever this other investment of theirs pays/costs.

Another “ideal scenario” for the above investor could be

• the worst-case scenario for SBI AT-1 bonds does occur after a few years
• and their total returns would include
  • >9% (from SBI AT-1 bonds) for a few years
  • and whatever this other investment of theirs pays/costs for a few years
  • a massive >10x payout at the end from their other investment.
  • loss of their principal in SBI AT-1 bonds
    • which they might be able to partially/fully avoid
      if they manage to time their exit from AT-1 bonds (before the worst-case scenario for SBI) in future
      even by selling at a small loss.

Note: Two perfectly inversely correlated investment assets in the above example are just to keep things simple. Perhaps it is not trivial to find such in real life. Investment portfolios may include multiple assets that hedge partially against some of the other assets in the portfolio, thereby reducing the overall risk of the investment portfolio.