Convertible Bonds Back In Favour As Equities Pick Up
However, the renaissance is notable as it follows a drought in issuance so severe that it threatened the sectors viability
. It also supports the thinking that the latest round of quantitative easing and efforts to stem the eurozone debt crisis are bringing relief to stock markets.
The data illustrate the story well. As much as $5.71bn in new convertibles have been issued in Europe since the start of September, with a further $4.77bn in the US, according to Nomura.
This burst of activity represents a sharp increase from the same period last year when, dragged down by the market downturn, just $1bn worth of convertibles were launched in Europe and $155m in the US.
The new issuance ranges from a double-B issue with a 4.5 per cent coupon, maturing in 2018, from Steinhoff, a South African home furnishing group, to a triple-B issue with a 5.75 per cent coupon and a 2016 maturity date from Ares Capital, a US credit strategist, and a 2015 double-B minus rated issue with a 4.5 per cent coupon from Shui on Land, a Chinese property company.
Last year was a terrible year for convertible bond issuance, says Akin Akinloye, head of the convertibles team with the hedge fund manager Cheyne Capital. But this recent resurgence of interest signals that the valve has been released on the pent-up demand that was there for these products.
This asset class is not facing extinction.
For investors, the great attraction of these hybrid bonds which pay a fixed-income but convert into shares at a pre-agreed price is that they offer a chance to gain exposure to any upswing in a companys share price, but provide the security of a bond as a fallback. Simply put, they can offer equity-style returns, but boast lower volatility. The five-year annualised volatility rate for convertible bonds is just 8 per cent compared to 21 per cent for equities, according to a recent presentation from Lombard Odier.
The chief appeal, meanwhile, for listed companies is that issuance costs for convertibles are lower than that of standard debt and they offer a quicker route to raising capital than a bond roadshow.
As the credit crisis drags on, companies are also seeking out alternative sources of financing as they try to pare back their dependence on bank loans, says Nathalia Barazal, head of convertible bonds at Lombard Odier. Companies have a need to diversify their sources of financing. The crisis is particularly acute in Europe and European banks have less money to lend and as a consequence they are becoming more selective about which companies they lend to, she says.
Current conditions continue to encourage the dominance convertible bonds now enjoy in the market. The prospect of interest rates remaining low for years coincides with a fear of sharply higher inflation in some quarters; this eventuality could sharply reduce real returns on straight bond portfolios.
These real returns which take into account inflations corrosive influence are already, in many cases, negative. UK, German and US government 10-year bond yields hover below 2 per cent, at lows not seen in decades and below national measures of inflation.
As a result, more investors are looking to convertible bonds, which have historically had higher Sharpe ratios, a measure of risk-adjusted return, than a mix of standard corporate bonds and equities.
An analysis of the performance of the UBS Global Investment Grade Hedged Convertible index against the MSCI World Equity Index over the past 20 years shows that convertible bonds tend to do well when stock markets rally and reduce losses when market conditions weaken.
The reason convertibles have outperformed equities is that they offer capital protection on the downside and you get this compounding effect on your investment that you dont get with equities, says Mike Reed, a fund manager with BlueBay Asset Management.
But it must be noted that the rebound in convertible bond issuance looks tepid in a historical context. More than $200bn of convertibles debuted in 2007 and issuance eclipsed $100bn in both 2008 and 2009 as well, according to Shawn Mato, a senior fund manager with Aviva Investors.
Its good to see the issuance. We hope it will continue, says the cautious Mr Mato. But its a flurry of issuance and if equities were to sell off, you wouldnt see much issuance of convertible bonds.
Mike Reed of BlueBay Asset Management, is just as sceptical, warning that the pick-up might reverse course if a catastrophic event hits debt markets.
Convertibles are a risk asset so if we were to see a sell-off in risk assets based on a credit event in Greece or Spain, the convertible market would take a hit, Mr Reed predicts. If the world goes down, markets do too. Convertibles would be hurt.
Darker days may lie around the corner. But if some level of market stability remains, Mr Akinloye of Cheyne Capital forecasts that demand for convertibles will stay buoyant.
Youre receiving an instrument that pays you to wait for performance. If it doesnt arrive, you get a capital return, he says. If you measure the performance of convertibles against cash and equity dividends, youll find that in many cases, youll get a higher yield from convertibles.
by: B2B Strategies
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