Mutual funds: Know the risks associated with AT1 & bonds

AT1 Bonds stand for additional tier-1 bonds. These are unsecured bonds that have perpetual tenure. In other words, the bonds have no maturity date. They have a call option, which can be used by the banks to buy these bonds back from investors.

Mutual funds are among the largest investors in the permanent debt segment and have AT1 bonds of more than 35,000 to 90,000 million.

The Securities and Exchange Board of India (Sebi) has limited investment in mutual funds in debt instruments, especially compared to AT1 bonds (Supplementary Level 1). Consequently, no mutual fund may invest more than 10% of its debt assets in such securities and not more than 5% in bonds of a single issuer. This decision caused shock waves in the stock and debt markets. We discussed in detail what an AT1 stock is and why Sebi imposes such restrictions from an investor’s perspective.

What is an AT1 connection?

An obligation is nothing more than a debt acknowledgment by a debtor (mortgagee), where an investor offers a loan to a debtor at a fixed rate with a predetermined frequency of payment and expiration date on which the debtor’s principal must pay. Features such as fixed-interest, fixed frequency, and reward at the end of the term provide the investor with certainty about the cash flow. But what makes AT1 bonds different is that they never expire, meaning bond issuers will never pay the principal.

Generally, AT1 bonds are issued by banks to form part of a fixed capital base. Interest can be left out of the account if the capital ratio of the bank falls below a certain percentage or if a loss occurs. These bonds are subordinate to all other debt and are only preferred over shares. These bonds offer better returns than the rest of the bonds, but they do not have an expiration date like other bonds. These types of securities are not suitable for investors with fixed income or bonds.

What are Sebi’s concerns?

Mutual funds are among the largest investors in the permanent debt segment and have AT1 bonds of more than 35,000 to 90,000 million. Sebi recently asked mutual funds to classify these perpetual bonds as a 100-year instrument, meaning that fund houses appreciate these bonds if they accept that they will pay out within 100 years. So far, mutual funds have valued the same by considering the call option date as the expiration date.

In addition, the regulator has also asked MFs to limit the ownership of the bonds to 10% of the plan’s assets, as Sebi believes these instruments are riskier than other debt instruments. However, the Treasury Department has asked Sebi to withdraw the circular as it could lead to disruptions to investments in mutual funds, particularly PSU banks. As a result, Sebi has simplified its previous order.

Ultimately, as an investor, you do not have to worry, even if your investment fund has consequences. Because the UCITS will gradually reduce its stake in these securities and stay within the limits prescribed by the regulator. However, it is a good idea to monitor your exposure to AT1 bonds when investing in a mutual fund.

OBLIGATIONS AT1

AT1 bonds never expire, which means mortgage lenders will never pay the principal.

AT1 securities are issued by banks to form part of a fixed capital base. Interest can be left out of the account if the capital ratio of the bank falls below a certain percentage or if a loss occurs.

AT1 bonds offer better returns than the rest of the bonds, but they do not have an expiration date like other bonds. These types of securities are not suitable for investors with fixed income or bonds.

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