Investing in AT-1 Bonds

Umm, for a debt MF 0.75% difference is big. It can make or break careers of fund managers :slight_smile:

because it’s not their capital :slight_smile:

Also, for all it’s shortcomings, defaults of AT-1 bonds over long period has been relatively low. Apart from Yes bank, hardly any big bank has defaulted on their AT-1. So looking at history, fund managers might consider this as acceptable risk.
Especially, much better track record than corporate boonds.

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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.

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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 :partying_face:)

:arrow_right: 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.

:arrow_right: 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.