The wipe-out of $17bn of Credit Suisse AT1s prompted Legal & General Investment Management's Matthew Rees to rethink exposure to financials.
Rees, who is head of global bond strategies at LGIM and co-manager of the L&G Strategic Bond fund, told Investment Week holding Credit Suisse AT1s was "the wrong decision", as it had caused the fund "some losses".
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He criticised Swiss regulator FINMA for its decision to "upset the credit hierarchy" by not wiping out equity before moving to bonds, but he did admit "we made the wrong decision to own them".
At the time, the Bank of England and European Central Bank provided reassurance they would have stuck to the credit hierarchy, which Rees deemed "comforting".
However, the manager said, if it came to it, they probably would have tried to "solve the systemic issues that Credit Suisse going bust would have caused" in a somewhat similar manner.
The "really unfortunate" situation with Credit Suisse is a "good reminder that securities are designed to take losses", he added.
The issues with the Swiss bank have shown that, regardless of who takes losses and at what level, "you still have to step back and understand what you are investing in", he said.
As a result, Rees and co-manager Colin Reedie were forced to limit their exposure to the bank's AT1s in the fund, which went from around 4.5% to below 2% following FINMA's action.
That does not mean AT1s or similar products do not have a place in an absolute return portfolio like the L&G Strategic Bond fund, he said.
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The manager explained such bonds will have a role to play only when you are being paid enough for the risk. He noted he and Reedie reduced the fund's exposure to subordinated debt to around 11-12% last year, which has now been further reduced to about 8% because "the subordination premium we think has to be bigger now".
He highlighted there has been a "good, strong rally in bank AT1s since Credit Suisse", but he did not believe they would pay enough, nor is the rally "high enough".
Despite the turmoil caused by the Swiss bank's near collapse and subsequent takeover by UBS, LGIM analysts found the European banking sector has got "good liquidity and less of the asset liability and mismatch risks, which caused the problems in the US", Rees said.
"The fundamentals of the banking sector are still a lot better than they were back in the financial crisis but there are there are still some areas of concern."
He added if they were to invest in financials again, the spotlight would need to be on liquidity and valuations due to how easily a bank run can take hold with the advent of internet banking.
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He admitted he would not bee surprised if there were some regulatory "knee jerk" leading to the tightening of banking regulation across both sides of the pond as a result of recent events.
He noted the banking turmoil in the US highlighted how regulators cannot "just focus on the top six banks", while the UK is already looking at raising the deposits guarantee thresholds, which could potentially lead to banks being forced to maintain higher levels of liquidity.
Such regulatory changes, Rees said, would give him, as well as other investors, "a bit more confidence".
The reduced exposure to financials, and especially to Credit Suisse AT1s, led to an increase in the Strategic Bond fund's cash buffer and a shift into shorter duration investment grade bonds, he said, especially considering the current economic backdrop of high inflation and interest rates.
Reducing exposure to financials was not only due to the events involving Credit Suisse, Rees explained, but also because "you are not being paid for the risk " of an increased possibility of a recession.
