Investors need a crystal ball for risk, not returns

“LEO, what do you think of this CoCo?”

Like clockwork, every few weeks for the last decade, one of our clients would forward an e-mail recommendation from a private bank on the newest subordinated Additional Tier-1 (AT1) issue. CoCos are contingent convertibles, which qualify as AT1 capital. As it is frequently issued, there is little wonder that CoCos – a new hybrid instrument created in the aftermath of the 2008 great financial crisis – have ballooned to over US$250 billion.

My answer was always the same: “Don’t buy it. You’re not getting paid for the risk.” Why would you invest in a security whose sole reason for existence is to provide a source of bank equity in times of crisis at investors’ expense – especially since by their nature banks tend to fail in a financial crisis? And all this risk for a 2 per cent pick-up in yield?