“There is no digital bank run in insurance”

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The head of fixed income at DCP Client Partner is convinced that hybrid bonds from Europe are attractive. However, he does not invest in AT1 bonds or Cocos and is otherwise quite picky. In conversation with finews.ch He reveals his investment criteria – and also comments on the Hochdorf case.

In Switzerland, the market for hybrid corporate bonds leads a shadowy existence. And when he does make headlines, they are definitely not flattering ones. The Lucerne milk processor Hochdorf became the first issuer of such a bond in francs to become insolvent this year.

Hochdorf had to flee into probate in August and has since sold its operational business. Back in the holding shell, there are few assets and many claims, including the 125 million franc bond launched in 2017. The obligations are only traded on the SIX Swiss Exchange at 5 percent of the nominal value.

An increasingly narrow niche in Switzerland

Corporate hybrids have always remained a niche on the Swiss market, which has become even narrower in recent years. Aside from Hochdorf, the club currently includes croissant maker Aryzta (which recently canceled one of its two hybrids) and food processor Hero; The electricity company Alpiq paid back its hybrid a few days ago.

The instrument differs from a normal bond in that it is subordinated in the capital structure and interest payments can be deferred. Accordingly, it is more expensive for a debtor than a conventional bond, but cheaper than stocks. Hybrid corporate bonds have a long to infinite term, but can be called by the debtor at certain dates.

Thriving market in Europe

The market in Europe looks completely different than in Switzerland. Companies such as the German Merck KGaA (pharmaceuticals), the Deutsche Börse, the French Orange (telecom) and Total (energy) have outstanding hybrid bonds with a total nominal value of around 175 billion euros. In addition, there are around 150 billion hybrids from insurance companies and 600 billion from banks; This also includes the AT-1 bonds or contingent convertibles (Cocos), which are known to a wider public in the Credit Suisse case and which financial institutions issue primarily for regulatory reasons.

“We don’t invest in AT1 bonds or Cocos,” says Sascha Peier fixed, at DCP Client Partner Head of Fixed Income & Senior Portfolio Manager and therefore responsible for the management of hybrid bonds. “These instruments stipulate that the investor has to accept shares or depreciation in certain, even unquantifiable cases – and we don’t want that.”

Same probability of default as regular bonds

Peier, who has been intensively involved in the hybrid market for years, only invests in commitments. “Hybrids have the same probability of default as senior bonds. However, if there is a default, investors must expect a loss due to the higher subordination.

The bond area that Peier manages currently has a total volume of 700 million francs. Most of it is invested in hybrid instruments. “The fund contains around 100 to 110 issues from 60 borrowers, including some Swiss names; The external bonds have a rating in the high triple-B range, the borrowers have a single-A rating, which is above average,” is how he characterizes the portfolio.

Thanks to SST regulation, there is a lot of equity in insurance balance sheets

Peier gives preference to securities from insurance companies over subordinated securities from banks (without conversion options, i.e. no AT1 or Cocos). “There can be no digital bank run when it comes to insurance. “In addition, the regulation, the Swiss Solvency Test SST, ensures that insurance companies have to accumulate sufficient equity, which is of course positive from a bondholder’s perspective.”

The average remaining term (duration) is rather short because the added value should not be achieved by playing with the term, but rather by selecting bonds with favorable ratings. Peyer: “We don’t make interest rate bets.”

Hybrids only late as a collective vessel

The total expense ratio (TER) is 1 percent and the fund is available in different currency tranches. With a return of 4 percent in francs, it offers a considerable premium compared to federal bonds (the ten-year Swiss yield is 0.4 percent) and the Swiss Bond Index (0.8 percent).

“For a long time we only used hybrids in discretionary mandates and only launched the collective vessel relatively late, in 2017,” regrets Peier, who also invested his own money in it. He still sees growth potential for his fund, which currently has 175 million francs: with the current strategy, the maximum is between 2 and 3 billion euros. “Our competitors are based abroad; there are hardly any providers in Switzerland.”