2019: are convertible bonds making a comeback?
An asset class with a real edge
The convertible bond is a classic bond with a twist: the right to convert into shares of the issuing company, making it a hybrid instrument that is highly adaptable to varied market environments, and particularly useful in turbulent equity markets.
There is a lot to like about convertible bonds. Their long-term performance is comparable to that of equities (annualised performance of the Exane ECI Europe TR was +3.95% over the last 20 years, against +3.61% for the Stoxx Europe 600 NR) with between half and a third the volatility (annual volatilities of respectively 7.7% and 18.5% for the same indices over this period). The protection offered by bonds – redemption price is known in advance – also means that investors can capture some of the upside of equity markets but suffer a smaller part of the downside.
Finally, convertible bonds have historically done well in times of rising rates (due to short duration relative to other fixed-income assets, and optionality). This makes them an attractive play in the context of monetary policy normalisation.
Major indices ended January with positive performances. But 2019 is shaping up to be a year of volatile markets. Political instability and monetary tightening in the US are clouding visibility for investors and, with eurozone sovereign debt paying historically low yields, finding new sources of yield has become essential. This environment seems particularly suitable for convertible bond investing, especially since the asset class is currently looking very attractive.
An attractive market for convertibles
Trading at discounts
2018 ended six years of unbroken gains for convertible bonds. The recent dip largely reflects underperformances of blue chip convertible underlyings against equity indices (-18% vs. -14% for the Euro STOXX 50) and mid-cap underlyings (-26.3% vs. -15.9% pour le MSCI Europe SMID), as well as a sharp widening of credit spreads on investment grade and high yield. The European pool of convertible bonds is currently trading at a marked discount and has therefore rebuilt its upside for 2019.
Convexity looking attractive again
Nearly 50% of European convertible bonds in issue are now well placed in the “mixed” zone, with an equity sensitivity between 20% and 80%, a profile that can maximise the appeal of the asset class (higher upside on market rises but a floor to cushion the falls).
Positive yields are back
We are seeing many convertibles return to positive or zero yield: this applies to over 60% of issues compared to just 48% a year ago.
Improved credit quality
Credit quality in the convertibles universe has shown a sharp improvement. More than 70% of issuers are now rated investment grade vs. 45% at 31/12/2017. Credit quality also reflects a healthy sector diversification in the pool, unlike the US, for instance, where risky sectors like techs and biotechs are overrepresented.
More liquid pool of instruments
More than 50% of convertible bonds have issue volumes above €500M, compared to less than 40% at end-2017, which means the European bond pool now offers better liquidity.
The market fall has narrowed the distance to bond floor and restored an attractive convexity at historically low prices.
2 mutual funds, 2 investment profiles for this asset class
At La Financière de l’Echiquier, we manage convertible bonds via two complementary strategies. Echiquier AltaRocca Convertibles has adopted an investment approach based on in-depth credit analysis within the asset class. Echiquier Convexité Europe adopts a more equities-sensitive approach, centred on convexity research.
At this time of market volatility, portfolio diversification must remain a key objective. Convertible bonds are a hybrid instrument by nature and capture part of the rise in equity markets while limiting the risk of capital loss.
Echiquier AltaRocca Convertibles A: FR0011672799
Echiquier AltaRocca Convertibles I: FR0011672807
Echiquier Convexité Europe A: FR0010377143
Echiquier Convexité Europe I: FR0010383448
Data as at 31/12/2018. This document is intended for wealth management professionals. It has no contractual force and does not represent investment advice of any kind. It cannot be passed on to third parties except with the prior consent of La Financière de l’Echiquier. The opinions contained in this document reflect LFDE’s expectations for the market at the time of its publication. These are likely to change in light of market conditions and in no circumstances can LFDE be held contractually liable in respect of them. Information on UCITS managed by La Financière de l’Echiquier is given for indicative purposes only. Before investing in any of these funds, potential investors are strongly recommended to conduct a detailed assessment of the risks to which these asset classes are exposed, notably the risk of capital loss. For further information on the La Financière de l’Echiquier range, please go to our website: www.lfde.com.
La Financière de l’Echiquier, société anonyme (limited liability company) with share capital of 10,000,000 euros, registered office 53, avenue d’Iena, 75116 Paris. Registered under no. 352 045 454 in the Paris Trade and Companies Register. It is authorised as a portfolio management company by the AMF (Autorité des Marchés Financiers) under no. GP 91-004.
Stéphanie Bobtcheff, fundmanager of Echiquier Agenor SRI Mid Cap Europe