The Invesco Perpetual Corporate Bond fund used the recent sharp volatility in bond markets to add to contingent convertible (CoCo) bonds, including those issued by Deutsche Bank.
The fund added in debt “across the capital structure” as bond markets shot up and down, although liquidity hampered some of its access, according to co-manager Mike Matthews.
Mr Matthews said that he and veteran colleagues Paul Causer and Paul Read had also been caught off guard with their bearish sentiment towards government bonds.
However, the trio’s favouring of financials has continued, as the managers have added to tier 2, additional tier 1 (AT1) and tier 1 debt.
Mr Matthews said they had kept faith with AT1 CoCos despite the negative sentiment seen earlier this year. The bonds had suffered as investors became concerned over the potential suspension of coupon payments.
The manager said the £5.2bn fund topped up on instruments after volatility which saw Deutsche Bank hit by severe negative sentiment, and the AT1 sector fall almost 10 percentage points before rising back to previous levels.
“Credit markets have been brutal this year,” he said. “The AT1 CoCo market was the best performing sector in 2015.
“Everyone was nervous, but in reality you had liquidity, which produced a decent yield and it was not that volatile. But that all changed at the start of this year.”
Mr Matthews blamed the shifting sentiment around AT1s on confusion between market participants and regulators, exacerbated by market illiquidity. He said: “The problem you had was once you started to see some price falls it all became self-fulfilling. Liquidity dries up very quickly.
“It was liquid last year because volatility was low, but as soon as volatility picks up you start to see some price falls, and one leads to another.”
Despite the AT1 market declines, Mr Matthews said he had struggled to take advantage of the opportunity in cases such as that of Deutsche Bank.
He said of eight banks he requested for Deutsche Bank AT1s, only two had any to sell.
“There have been a couple of larger funds that had outflows so you were able to buy what they were selling. But with Deutsche Bank in the eye of the storm, trying to buy its AT1s was not easy when they were falling.”
However, Mr Matthews said the market had reversed by mid-March, when Swiss banking giant UBS was the first to issue such debt after the dip.
Investors made more than $8bn (£5.7bn) of orders for a $1.5bn tranche of five-year AT1s yielding 6.9 per cent.
In the previous week, market makers were struggling to sell a UBS AT1 with a 9 per cent yield trading at 15 points below par (85), according to Mr Matthews.
“We have gone from a market where people were worried about liquidity, volatility, Deutsche Bank and coupons being switched off, to suddenly being back open and UBS having an $8bn order book,” he added.