AT1s have had a terrific 21 months. If you had bought a portfolio of the bonds the morning after Credit Suisse’s own AT1s were written down to zero, it would have returned 40.6%1. Effectively you have had equity-like returns for bond-like risk. This should not be a surprise as at the time AT1 bonds yielded 10.3%, a pick-up over government bonds yields of 709bps. Be greedy when others are fearful.

But they are risky, no? Well, according to regulators, yes. The FCA sees them as weapons of mass destruction2, banning retail investors from owning them – putting aside the fact these same investors can buy much riskier asset classes including emerging markets, buy European bank ETFs or trade CFDs. Australian regulators have even gone a step further and called it a day on AT1 bonds, phasing them out as of capital for banks from 2027.

We think this risk is misplaced. Today, capital ratios and profitability are at their strongest levels in years, driven in part by higher interest rates, while loan books have been materially derisked, with bad debts now at historically low levels – as referenced by the European Central Bank and Bank of England in their respective Financial Stability Reviews, published in November 2024.

Financial companies are not immune from a cyclical downturn, but as KBW’s UK banks analyst succinctly commented in a recent note: “UK banks have survived a fall in GDP of 10%, interest rates rising by 5% and inflation peaking at more than 11% with zero credit problems”. Crucially, this analogy is applicable across a number of other banking markets.

The consequence of the strong performance, however, has been a significant tightening in spreads.

History of AT1 bond yield spreads
History of AT1 bond yield spreads
Source: ICE BofA, spread to worst (US$); 20 Jan 2025.


Could we see a further narrowing? Absolutely. Financial companies not only do not default that frequently, with statistics from Moody’s showing it occurs less than half the time of non-financials, but spreads were also tighter pre-2007. Furthermore, thanks to an increase in government bond yields, the overall yield on offer is still relatively attractive – 6.6% as of 16 January 2025 (on a US dollar basis).

AT1s are, however, not without risks. To date, c95% of banks have called3 their AT1s at the first opportunity, making the instruments relatively short-dated. However, in risk-off environments, the probability of a bank not calling its bonds increases and the bonds become priced more like perpetuals – which they fundamentally are. AT1 coupons are discretionary so the fear they are suspended, albeit very small, will increase in a selloff. This combination on performance in risk-off events can be seen below.

Largest drawdowns in financial bonds over the past 10 years
Largest drawdowns in financial bonds over the past 10 years
Source: ICE BoA; 20 Jan 2025; *The ICE BofA Global Financials Index consists principally of senior (82%) and tier 2 (15%) bonds.


Today, AT1 bonds offer bond-like returns for bond-like risk, but with the tail risk that you could suffer a sharp drawdown in a risk-off environment, despite strong fundamentals.

Where do we see better value?

  • Higher up the capital stack in Tier 2 and senior bonds
  • In UK financials, where spreads remain wider
  • Across peripheral European banks
  • In some smaller and mid-sized financial institutions
  • In the remaining buckets of legacy debt4


1. ICE BofA Contingent Convertible Index 20 March 2023 to 20 January 2025 USD Hedged

2. The FCA would describe them as "risky and highly complex instruments"

3. AT1 bonds are perpetual instruments issued with call dates normally five years from the date of issue where the bank has the right, but not the obligation, to call the bond back at par. If it does not, the coupon will reset to a set yield above the prevailing five-year government bond at that time

4. Legacy debt is so-called as the securities in question no longer count towards regulatory capital

Risks

  • Capital is at risk and there is no guarantee the Fund will achieve its objective. Investors should make sure their attitude towards risk is aligned with the risk profile of the Fund before investing.
  • Past performance is not a reliable guide to future performance. The value of investments may go down as well as up and you might get back less than you originally invested as there is no guarantee in place.
  • The value of a fund’s assets may be affected by uncertainties such as international political developments, market sentiment, economic conditions, changes in government policies, restrictions on foreign investment and currency repatriation, currency fluctuations and other developments in the laws and regulations of countries in which investment may be made. Please see the Fund’s Prospectus for details of all risks.
  • The Fund invests in the shares of companies, and share prices can rise or fall due to several factors affecting global stock markets.
  • The Fund uses derivatives which carry the risk of reduced liquidity, substantial loss, and increased volatility in adverse market conditions, such as failure amongst market participants.
  • The Fund invests in assets denominated in currencies other than the Fund's base currency. Changes in exchange rates may have a negative impact on the Fund's investments. If the share class currency is different from the currency of the country in which you reside, exchange rate fluctuations may affect your returns when converted into your local currency.
  • The Fund invests in emerging markets where there is a greater risk of volatility due to political and economic uncertainties, restrictions on foreign investment, currency repatriation and currency fluctuations. Developing markets are typically less liquid which may result in large price movements to the Fund.
  • The Fund invests in a relatively concentrated number of companies and industries based in one sector. This focused strategy can produce high gains but can also lead to significant losses. The Fund may be less diversified than other investment funds.


Important Information
This is a marketing communication and does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments. Any opinions expressed may change. This document does not contain information material to the investment objectives or financial needs of the recipient. This document is not advice on legal, taxation or investment matters. Tax treatment depends on personal circumstances. Investors must rely on their own examination of the Fund or seek advice. Investment may be restricted in other countries and as such, any individual who receives this document must make themselves aware of their respective jurisdiction and observe any restrictions.

A decision may be taken at any time to terminate the marketing of the Fund in any EEA Member State in which it is currently marketed. Shareholders in the affected EEA Member State will be given notification of any decision and provided the opportunity to redeem their interests in the Fund, free of any charges or deductions, for at least 30 working days from the date of the notification.

Investment in the Fund is an investment in the shares of the Fund and not in the underlying investments of the Fund. Further information about fund characteristics and any associated risks can be found in the Fund’s Key Investor Document or Key Investor Information Document (“KID” or “KIID”), the Prospectus (and relevant Fund Supplement), the Articles of Association and the Annual and Semi-Annual Reports. Please refer to these documents before making any final investment decisions. Investment in the Fund concerns shares of the Fund and not in the underlying investments of the Fund.  These documents are available free of charge at Polar Capital Funds plc, Georges Court, 54-62 Townsend Street, Dublin 2, Ireland, via email by contacting Investor-Relations@polarcapitalfunds.com or at www.polarcapital.co.uk. The KID is available in the languages of all EEA member states in which the Fund is registered for sale; the Prospectus, Annual and Semi-Annual Reports and KIID are available in English.

The Fund promotes, among other characteristics, environmental or social characteristics and is classified as an Article 8 fund under the EU's Sustainable Finance Disclosure Regulation (SFDR). For more information, please see the Prospectus and relevant Fund Supplement.

ESG and sustainability characteristics are further detailed on the investment manager’s website: - https://www.polarcapital.co.uk/ESG-and-Sustainability/Responsible-Investing/.

A summary of investor rights associated with investment in the Fund is available online at the above website, or by contacting the above email address. A link to the document can be found here.

This document is provided and approved by both Polar Capital LLP and Polar Capital (Europe) SAS.

Polar Capital LLP is authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom, and the Securities and Exchange Commission (“SEC”) in the United States. Polar Capital LLP’s registered address is 16 Palace Street, London, SW1E 5JD, United Kingdom.

Polar Capital (Europe) SAS is authorised and regulated by the Autorité des marchés financiers (AMF) in France. Polar Capital (Europe) SAS’s registered address is 18 Rue de Londres, Paris 75009, France.

Polar Capital LLP is a registered Investment Advisor with the SEC. Polar Capital LLP is the investment manager and promoter of Polar Capital Funds plc – an open-ended investment company with variable capital and with segregated liability between its sub-funds – incorporated in Ireland, authorised by the Central Bank of Ireland and recognised by the FCA. Bridge Fund Management Limited acts as management company and is regulated by the Central Bank of Ireland. Registered Address: Percy Exchange, 8/34 Percy Place, Dublin 4, Ireland.

Benchmark: The Fund is actively managed and uses the MSCI ACWI Financials Net TR Index as a performance target and to calculate the performance fee. The benchmark has been chosen as it is generally considered to be representative of the investment universe in which the Fund invests. The performance of the Fund is likely to differ from the performance of the benchmark as the holdings, weightings and asset allocation will be different. Investors should carefully consider these differences when making comparisons. Further information about the benchmark can be found www.mscibarra.com. The benchmark is provided by an administrator on the European Securities and Markets Authority (ESMA) register of benchmarks which includes details of all authorised, registered, recognised, and endorsed EU and third country benchmark administrators together with their national competent authorities.

Third-party Data: Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved in or related to compiling, computing or creating the data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any data contained herein.

Country Specific Disclaimers: When considering an investment into the Fund, you should make yourself aware of the relevant financial, legal and tax implications. Neither Polar Capital LLP nor Polar Capital Funds plc shall be liable for, and accept no liability for, the use or misuse of this document.

None

AT1s have had a terrific 21 months. If you had bought a portfolio of the bonds the morning after Credit Suisse’s own AT1s were written down to zero, it would have returned 40.6%1. Effectively you have had equity-like returns for bond-like risk. This should not be a surprise as at the time AT1 bonds yielded 10.3%, a pick-up over government bonds yields of 709bps. Be greedy when others are fearful.

But they are risky, no? Well, according to regulators, yes. The FCA sees them as weapons of mass destruction2, banning retail investors from owning them – putting aside the fact these same investors can buy much riskier asset classes including emerging markets, buy European bank ETFs or trade CFDs. Australian regulators have even gone a step further and called it a day on AT1 bonds, phasing them out as of capital for banks from 2027.

We think this risk is misplaced. Today, capital ratios and profitability are at their strongest levels in years, driven in part by higher interest rates, while loan books have been materially derisked, with bad debts now at historically low levels – as referenced by the European Central Bank and Bank of England in their respective Financial Stability Reviews, published in November 2024.

Financial companies are not immune from a cyclical downturn, but as KBW’s UK banks analyst succinctly commented in a recent note: “UK banks have survived a fall in GDP of 10%, interest rates rising by 5% and inflation peaking at more than 11% with zero credit problems”. Crucially, this analogy is applicable across a number of other banking markets.

The consequence of the strong performance, however, has been a significant tightening in spreads.

History of AT1 bond yield spreads
History of AT1 bond yield spreads
Source: ICE BofA, spread to worst (US$); 20 Jan 2025.


Could we see a further narrowing? Absolutely. Financial companies not only do not default that frequently, with statistics from Moody’s showing it occurs less than half the time of non-financials, but spreads were also tighter pre-2007. Furthermore, thanks to an increase in government bond yields, the overall yield on offer is still relatively attractive – 6.6% as of 16 January 2025 (on a US dollar basis).

AT1s are, however, not without risks. To date, c95% of banks have called3 their AT1s at the first opportunity, making the instruments relatively short-dated. However, in risk-off environments, the probability of a bank not calling its bonds increases and the bonds become priced more like perpetuals – which they fundamentally are. AT1 coupons are discretionary so the fear they are suspended, albeit very small, will increase in a selloff. This combination on performance in risk-off events can be seen below.

Largest drawdowns in financial bonds over the past 10 years
Largest drawdowns in financial bonds over the past 10 years
Source: ICE BoA; 20 Jan 2025; *The ICE BofA Global Financials Index consists principally of senior (82%) and tier 2 (15%) bonds.


Today, AT1 bonds offer bond-like returns for bond-like risk, but with the tail risk that you could suffer a sharp drawdown in a risk-off environment, despite strong fundamentals.

Where do we see better value?

  • Higher up the capital stack in Tier 2 and senior bonds
  • In UK financials, where spreads remain wider
  • Across peripheral European banks
  • In some smaller and mid-sized financial institutions
  • In the remaining buckets of legacy debt4


1. ICE BofA Contingent Convertible Index 20 March 2023 to 20 January 2025 USD Hedged

2. The FCA would describe them as "risky and highly complex instruments"

3. AT1 bonds are perpetual instruments issued with call dates normally five years from the date of issue where the bank has the right, but not the obligation, to call the bond back at par. If it does not, the coupon will reset to a set yield above the prevailing five-year government bond at that time

4. Legacy debt is so-called as the securities in question no longer count towards regulatory capital

Related Fund

Risks

  • Capital is at risk and there is no guarantee the Fund will achieve its objective. Investors should make sure their attitude towards risk is aligned with the risk profile of the Fund before investing.
  • Past performance is not a reliable guide to future performance. The value of investments may go down as well as up and you might get back less than you originally invested as there is no guarantee in place.
  • The value of a fund’s assets may be affected by uncertainties such as international political developments, market sentiment, economic conditions, changes in government policies, restrictions on foreign investment and currency repatriation, currency fluctuations and other developments in the laws and regulations of countries in which investment may be made. Please see the Fund’s Prospectus for details of all risks.
  • The Fund invests in the shares of companies, and share prices can rise or fall due to several factors affecting global stock markets.
  • The Fund uses derivatives which carry the risk of reduced liquidity, substantial loss, and increased volatility in adverse market conditions, such as failure amongst market participants.
  • The Fund invests in assets denominated in currencies other than the Fund's base currency. Changes in exchange rates may have a negative impact on the Fund's investments. If the share class currency is different from the currency of the country in which you reside, exchange rate fluctuations may affect your returns when converted into your local currency.
  • The Fund invests in emerging markets where there is a greater risk of volatility due to political and economic uncertainties, restrictions on foreign investment, currency repatriation and currency fluctuations. Developing markets are typically less liquid which may result in large price movements to the Fund.
  • The Fund invests in a relatively concentrated number of companies and industries based in one sector. This focused strategy can produce high gains but can also lead to significant losses. The Fund may be less diversified than other investment funds.


Important Information
This is a marketing communication and does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments. Any opinions expressed may change. This document does not contain information material to the investment objectives or financial needs of the recipient. This document is not advice on legal, taxation or investment matters. Tax treatment depends on personal circumstances. Investors must rely on their own examination of the Fund or seek advice. Investment may be restricted in other countries and as such, any individual who receives this document must make themselves aware of their respective jurisdiction and observe any restrictions.

A decision may be taken at any time to terminate the marketing of the Fund in any EEA Member State in which it is currently marketed. Shareholders in the affected EEA Member State will be given notification of any decision and provided the opportunity to redeem their interests in the Fund, free of any charges or deductions, for at least 30 working days from the date of the notification.

Investment in the Fund is an investment in the shares of the Fund and not in the underlying investments of the Fund. Further information about fund characteristics and any associated risks can be found in the Fund’s Key Investor Document or Key Investor Information Document (“KID” or “KIID”), the Prospectus (and relevant Fund Supplement), the Articles of Association and the Annual and Semi-Annual Reports. Please refer to these documents before making any final investment decisions. Investment in the Fund concerns shares of the Fund and not in the underlying investments of the Fund.  These documents are available free of charge at Polar Capital Funds plc, Georges Court, 54-62 Townsend Street, Dublin 2, Ireland, via email by contacting Investor-Relations@polarcapitalfunds.com or at www.polarcapital.co.uk. The KID is available in the languages of all EEA member states in which the Fund is registered for sale; the Prospectus, Annual and Semi-Annual Reports and KIID are available in English.

The Fund promotes, among other characteristics, environmental or social characteristics and is classified as an Article 8 fund under the EU's Sustainable Finance Disclosure Regulation (SFDR). For more information, please see the Prospectus and relevant Fund Supplement.

ESG and sustainability characteristics are further detailed on the investment manager’s website: - https://www.polarcapital.co.uk/ESG-and-Sustainability/Responsible-Investing/.

A summary of investor rights associated with investment in the Fund is available online at the above website, or by contacting the above email address. A link to the document can be found here.

This document is provided and approved by both Polar Capital LLP and Polar Capital (Europe) SAS.

Polar Capital LLP is authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom, and the Securities and Exchange Commission (“SEC”) in the United States. Polar Capital LLP’s registered address is 16 Palace Street, London, SW1E 5JD, United Kingdom.

Polar Capital (Europe) SAS is authorised and regulated by the Autorité des marchés financiers (AMF) in France. Polar Capital (Europe) SAS’s registered address is 18 Rue de Londres, Paris 75009, France.

Polar Capital LLP is a registered Investment Advisor with the SEC. Polar Capital LLP is the investment manager and promoter of Polar Capital Funds plc – an open-ended investment company with variable capital and with segregated liability between its sub-funds – incorporated in Ireland, authorised by the Central Bank of Ireland and recognised by the FCA. Bridge Fund Management Limited acts as management company and is regulated by the Central Bank of Ireland. Registered Address: Percy Exchange, 8/34 Percy Place, Dublin 4, Ireland.

Benchmark: The Fund is actively managed and uses the MSCI ACWI Financials Net TR Index as a performance target and to calculate the performance fee. The benchmark has been chosen as it is generally considered to be representative of the investment universe in which the Fund invests. The performance of the Fund is likely to differ from the performance of the benchmark as the holdings, weightings and asset allocation will be different. Investors should carefully consider these differences when making comparisons. Further information about the benchmark can be found www.mscibarra.com. The benchmark is provided by an administrator on the European Securities and Markets Authority (ESMA) register of benchmarks which includes details of all authorised, registered, recognised, and endorsed EU and third country benchmark administrators together with their national competent authorities.

Third-party Data: Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved in or related to compiling, computing or creating the data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any data contained herein.

Country Specific Disclaimers: When considering an investment into the Fund, you should make yourself aware of the relevant financial, legal and tax implications. Neither Polar Capital LLP nor Polar Capital Funds plc shall be liable for, and accept no liability for, the use or misuse of this document.