MARKET COMMENTARY
When we predicted at the end of 2024 that 2025 might hold some surprises, we certainly did not anticipate so many, so quickly. Geopolitical risk (check), Transactional Trump (check), higher volatility or at least regular spikes (check), Europe closing the gap with the US (check) and a broadening of performance away from the Magnificent Seven into other parts of the market (check). The good news for convertible bond investors is that the asset class did what it is designed to do – in February, global balanced convertibles outperformed the MSCI World and high-yield credit, performed in line with investment-grade and participated with 75% of the performance of the underlying equities. Asian convertibles have done particularly well: over one and 10 years, they have outperformed bonds (JPM JACI Core 1+ USD) and captured almost all of the equity upside (MSCI Asia ex-Japan USD); over three and five years, they have outperformed both bonds and equities.
European governments were left scrambling to boost their defence budgets after President Trump withdrew US support for Ukraine and, in no uncertain terms, declared that America could no longer be counted on to finance or arm conflicts on foreign soil. A rather chastened President Zelensky returned to Kyiv and issued a hurried apology in the hope that US-led negotiations with Moscow might resume and subsequently result in a mutually palatable solution. MAGA (Make America Great Again) has turned into MEGA (Make Europe Great Again), pushing the DAX more than 12% ahead of the S&P500 year-to-date. The outcome of the German election was an unsurprising win for the right-wing CDU/CSU, with Friederich Merz the frontrunner to become Chancellor if he can negotiate a working coalition. More of a surprise was the proposed fiscal package that meaningfully changes the medium-term economic outlook for Europe’s largest economy.
The other big winners of 2025 have been the main Asian Technology names (e.g. Alibaba and Xiaomi), which have rallied massively on AI optimism, despite the threat of a trade war with the US. Alibaba stock has risen 60% year-to-date and, as one of the biggest deals in our universe, the name has generated generous returns for convertible investors. The Chinese authorities are firmly back in the driving seat, and we expect that further stimulus measures will be announced at crucial policy meetings in early March.
For every winner, there has to be a loser, and this dubious accolade has fallen on the Magnificent Seven and the NASDAQ, which have been feeling somewhat unloved in recent weeks. There was a nasty sell-off in US stocks in the second half of the month after preliminary PMI (Purchasing Managers’ Index) readings showed that US business growth is close to grinding to a halt. Despite the negative news flow, the US consumer remains employed, real incomes continue to rise, inflation is at/close to target and the Federal Reserve is likely to look through the recent tariff-driven inflation spike when considering the future path of US interest rates.
NEW ISSUANCE
The primary market got off to a slow start in January, but the pace improved in February after the US Q4 earnings blackout was lifted. Globally, USD 6.3 bn was priced last month, almost double January’s total, largely dominated by the US (USD 5.3 bn). Despite some investor fatigue, repeat crypto issuer Microstrategy raised a further USD 2 bn via a 0% coupon deal due in 2030. There were also deals from Unity Software, BridgeBio Pharma and the Cheesecake Factory, which was gobbled up by investors. In Asia, there was a deal by repeat issuer IQIYI Inc, and a synthetic issue for Vinci SA in Europe.
PERFORMANCE
The Fund rose 3.2% in February, 30 bps ahead of the benchmark index for a year-to-date total of 4.4%, 25 bps ahead of the FTSE Asia ex-Japan convertible bond index. The MSCI Asia ex-Japan equity index rose 1.0%, the JPM JACI credit gauge gained 1.8%, the VIX volatility gauge ticked up from 16% to 21% and credit spreads closed the month unchanged. The main performance drivers were all positive in February (equity, credit, income, rates, volatility). By region, in absolute terms, Asia rose 3.3% and Europe gained 0.2%. In relative terms, Asia added 48 bps and Europe contributed 16 bps.
Most sectors were positive, led higher by Technology (+1.5%), Communications (+0.9%) and Consumer Cyclicals (+0.5%).
In Technology, hardware and equipment names did best (Xiaomi +145 bps, Lenovo +72 bps). There was weakness in some of the chip-related names (TSMC -11 bps, SK Hynix -10 bps, Hon Hai Precision -8 bps, Samsung Electronics -4 bps) and the main contributor to relative performance was the overweight in Xiaomi (+18 bps).
The biggest contribution in Communications came from Asian media and gaming giant Tencent, which added 73 bps after an almost 20% rise in the share price in February. Kakao and Kingsoft added a further 13 bps, while Tencent (overweight) added 49 bps to relative performance.
The returns in Consumer Cyclicals were spread over a number of names. The off-benchmark position in Alibaba added 19 bps (absolute and relative). European food delivery platform Delivery Hero added a further 7 bps (absolute and relative) and sportswear manufacturer and retailer Anta Sports contributed 22 bps to headline returns.
OUTLOOK
Convertible bonds have had a strong start to the year. Having been penalised for its lack of Magnificent Seven in recent years, the universe is now outperforming as gains have spread more broadly into other sectors and themes. Asian cyclicals have had a particularly strong start. Convexity has returned to the asset class, issuance is buoyant and many of the quality growth themes in convertibles are aligned with government policy and technological innovation. We are constructive on the potential for the asset class to generate returns in 2025.
