Filling the $45 billion hole in Australian investors' portfolios

With the $40-50 billion Additional Tier 1 (AT1) hybrid securities market set to be phased out by 2032, Australian investors face a major portfolio shake-up. As the Australian Prudential Regulation Authority (APRA) winds down these instruments, citing issues like their poor performance in the Credit Suisse collapse, retail investors must now seek income alternatives.

In the conversation above, VanEck Senior Portfolio Manager Cameron McCormack outlines three ETF-based options that investors can use to potentially fill the income gap: EBND, SUBD, and LEND. 

Each offers a distinct return profile and risk exposure, and while none are a direct replacement for hybrids, together they may help construct a well-rounded income portfolio.

Watch the video above for the full insights, or read an interview summary below. 

INTERVIEW SUMMARY

Why the hybrid phase-out is happening

According to McCormack, APRA’s decision boils down to functionality and investor protection. “They don’t see them as behaving as intended,” he says, pointing specifically to the Credit Suisse debacle, where AT1 securities were written off completely.

Australia is the first developed market to remove hybrids from the bank capital stack, making the transition a uniquely local challenge. “It’s very unique in that regard,” McCormack adds, noting that banks will instead issue subordinated debt and equity to replace the capital that hybrids previously filled.

Though the formal transition begins in 2027, the banks are already acting. “We’ve seen a range of ASX hybrids be called so far and haven’t reissued,” he says. That means investors need to prepare now.

Solution #1: EBND – Emerging market bonds with attractive yield

The first ETF McCormack highlights is the VanEck Emerging Income Opportunities Active ETF (Managed Fund) (ASX: EBND). “It’s our active emerging market bond ETF,” he explains, noting that it’s been the best-performing bond ETF on the market over the past five years.

One of VanEck's actively managed funds, EBND, offers a current yield of around 8% by investing in a mix of hard currency (USD-denominated) and local currency government and corporate bonds from emerging markets.

McCormack argues that these markets have evolved significantly. 

“They’ve matured over the last 25 years...They’re actually net lenders to other parts of the economy,” he says. 

And crucially, these countries are now far more fiscally disciplined than their developed counterparts.

Similarities and differences to AT1s: While EBND is very different from hybrids - it focuses on government bonds and is fixed rate, not floating - it offers strong yields and international diversification. 

“If you’re looking for more of a diversified offering...emerging markets certainly have shown their worth,” McCormack says.

Risks to note: EBND carries currency risk and geopolitical exposure, and its longer duration makes it more sensitive to interest rate changes.

Solution #2: SUBD – A natural hybrid alternative 

The VanEck Australian Subordinated Debt ETF (ASX: SUBD) may be the closest direct substitute for hybrids. “It sits one notch above ASX hybrids in the capital stack,” McCormack says, making it structurally similar but less risky.

SUBD invests in subordinated, floating-rate debt issued by major Australian banks and insurers (including the Big Four and Macquarie), as well as some foreign banks now tapping into this growing market. Typically, around 90% of the loans held are floating-rate, like hybrids. The ETF offers a yield approximately 60 basis points lower than hybrids, even accounting for franking credits, but the trade-off is greater capital security.

“We’ve recently seen offshore banks issuing into the Aussie market, and those securities come with a yield pickup of around 50 basis points,” McCormack adds, making them an attractive inclusion.

Similarities and differences to AT1s: Both are floating-rate and bank-issued, but SUBD bonds have higher seniority and less risk. “It’s probably the closest fit... the most natural replacement,” says McCormack.

Risks to note: SUBD offers a lower loss-absorption risk compared to AT1s. And since it’s a passive ETF tracking the iBoxx AUD Investment Grade Subordinated Debt Mid Price Index, it offers transparency and simplicity.

Solution #3: LEND – High-yield exposure via listed private credit

The final ETF is the VanEck Global Listed Private Credit ETF (ASX: LEND), offering double-digit yield potential by investing in US business development companies (BDCs).

“This is one of the few asset classes that offers a yield above 10%,” McCormack says. But it comes with more risk. BDCs lend directly to mid-market companies in the US - businesses that can’t access traditional loans from big banks.

Unlike Australian listed investment trusts (LITs), which often obscure their holdings, these US BDCs must disclose their portfolios quarterly, allowing for full transparency. Additionally, it offers sector diversification by primarily providing exposure to technology, consumer discretionary and industrials, as opposed to real estate development, which is commonplace in Australia.

“That’s the key differentiator,” says McCormack.

Another benefit: more than 90% of the loans held are floating-rate, like hybrids. “If you are more concerned about interest rate duration, but comfortable with potentially taking on more credit spread duration, then LEND could be one to consider,” he adds.

Similarities and differences to AT1s: Both are floating-rate, listed securities offering high yield, but LEND’s exposures are corporate and US-centric, not bank debt. “This one’s a bit higher up on the risk curve,” McCormack concedes.

How to use these products in practice

McCormack makes clear that none of these ETFs is a direct replacement for AT1s, but they can each serve a role. 

“The natural fit would be subordinated debt,” he says, due to its structural and yield similarity. But for a more diversified portfolio, he recommends blending options.

“If you’re looking to build out a more diversified, low-duration credit portfolio, then potentially a mix of subordinated debt and LEND… and if you want more duration, EBND is something to consider,” McCormack says.

“It’s important that investors understand what’s in those vehicles and the risks that come with them,” he says.