white papers

    Convertible bonds: a valuable tool during times of uncertainty

    Convertible bonds: a valuable tool during times of uncertainty
    Maxime Perrin - Head of Sustainable Investment

    Maxime Perrin

    Head of Sustainable Investment

    One of the lesser-known advantages of the convertible bond asset class is that growth companies are disproportionately represented when compared to global equities. Technology companies represent close to a quarter of the market, followed by the communications, consumer discretionary and industrial sectors. Many companies in these sectors are expected to outperform the market during and after the current pandemic-related crisis.

    The primary convertible bond market has been in rude health since the end of Q1 2020, boosted by an acceleration in new issuance. USD 92 billion of convertible bonds were issued in the first half of the year and if the current pace continues, 2020 will be the best year for issuance since 2007.

    Crucially for investors, this wave of new paper has been issued amid attractive technical profiles, as many companies are issuing convertible bonds before their shares have recovered from the significant market decline in March.  Additionally, diversification is increasing with issuance not only coming in the form of ‘rescue capital’ from those companies most affected by COVID-19, but also from high-growth companies in the technology and consumer sectors.

    Historically, convertible bonds have outperformed global equities during higher volatility environments

    After the coronavirus crisis tore through global financial markets March, and despite the strong market rebound in Q2, tactical opportunities around mispricing are unusually striking.  

    Following the sharp downturn in risky assets at the end of Q1 2020, the yields of a number of convertible bonds ended up higher than their equivalent straight bonds (same issuer, same seniority, similar maturity). This is not a common occurrence. In fact, the level of dislocation between the remuneration of credit risk of convertible bonds and straight bonds has not been seen since 2009.

    Additionally, the long-term options embedded in convertible bonds do not reflect recent equity market volatility, reinforcing the attractiveness of current valuations.

    The case for a strategic allocation to convertible bonds also remains strong. At heart, the asset class’ structural ability to retain upside equity exposure, while having an element of downside protection in the event of an equity correction – an asymmetrical return profile – underpins its long-term usefulness in strategic asset allocation.

    This asymmetry could prove especially valuable in the current market climate, where overall market returns may be constrained and volatility levels are elevated (historically, convertible bonds have outperformed global equities during higher volatility environments).

    In this white paper, we outline why convertible bonds are once again proving to be very valuable to investors during times of uncertainty.