MARKET COMMENTS
The year began with some heavy news flow; nevertheless, most risk assets closed a bumpy month higher despite escalating trade rhetoric, a possibly less certain path for interest rates and the DeepSeek shock, which temporarily caused investors to re-evaluate their lofty expectations for AI-generated returns. Markets gradually started to price in the inflationary effects of President Trump’s proposed policies, which pushed US 10-year yields back towards 5%. Trump signed a raft of radical executive orders, and the initial optimism gave the S&P500 an early boost. However, just after the inauguration celebration, an unexpected curveball hit global markets with the launch of DeepSeek, a lower-cost alternative to ChatGPT from China, wiping more than USD 600 billion from NVIDIA’s market capitalisation in one day and causing many names in the AI supply chain to plunge. Attention had been focussed more on the potential for the US cohort to generate significant medium-term returns, with most believing that US curbs on chip shipments and the sharing of technological know-how had been sufficient to put China out of the race, at least for now. The sell-off was painful but narrow and short-lived. Convertibles were largely protected from the downdraft, having only minimal exposure to Transactional Trump (e.g. traditional autos, luxury), and we used the DeepSeek air pocket to make some adjustments to our exposure.
In the midst of the AI angst, the US administration also announced tariffs on imports from Canada, Mexico and China, although discussions between Trump and some of the relevant premiers led to delays being negotiated. What this reinforced, if anyone had been under the illusion that Trump would not follow through on early promises, is that this new regime will lead to spikes in volatility, gains for some at the expense of heavy losses for others and a notably transactional skew to policy for the next four years. Proposals to buy Greenland from Denmark and make the Gaza Strip the new Riviera of the Middle East were met with derision, but they show the unpredictable nature of current geopolitics.
The prevailing sentiment of uncertainty made for a difficult start to the year for fixed-income investors. As well as the gap higher in US yields (before they moderated later in the month), UK 10-year borrowing costs rose to their highest level since the global financial crisis as the impact of the new Labour government’s budget raised fears of stagflation. Japanese yields also ticked higher. European equities did relatively better than expected in January, with several of the major indices hitting record highs. Despite uncertainty over the outcome of the looming election in Germany, the DAX outperformed the Magnificent Seven by six percentage points. The other beneficiary of the current environment is the gold price, which hit a record high last month. Inventories have risen 75% on the New York commodity exchange as traders hedge against a potential political shift in the US.
NEW ISSUANCE
After a strong year for primary in 2024, the new year got off to a slow start with just over USD 3 billion of issuance in January, driven exclusively by the US and Asia. The pipeline faced a number of headwinds, including Q4 earnings blackouts and US political uncertainty. Forecasts remain in the USD 80-100 billion range for the full year. In the US, Microstrategy issued a USD 730 million perpetual instrument and Vancouver-based gold producer B2Gold issued a USD 460 million deal with a 2.75% coupon. In Asia, electronic components manufacturer Delta Electronics issued a USD 525 million convertible with a 2030 maturity.
PERFORMANCE
The Fund returned 2.4% in January, 30 bps ahead of the benchmark. Over the same period, Investment Grade credit added 0.6%, high yield rose 1.1%, the MSCI World in EUR gained 3.4%, the ITRAXX Xover credit index tightened from 313 bps to 287 bps and Value outperformed Growth (4.4% vs 2.6%). All regions generated positive performance, led higher by the US +1.3%, Asia +0.7%, Europe +0.4% and Japan +0.1%. All regions also gained in relative terms; US +14 bps, Asia +12 bps, Europe and Japan +6 bps. All sectors also generated positive returns, with the strongest gains for Consumer Cyclicals +0.8%, Communications +0.4%, Technology +0.3% and Industrials +0.3%. The Asian Consumer Cyclicals led the way (Alibaba +0.4%, JD.com +0.2%), followed by Norwegian Cruise Lines and Wayfair in the US, Accor and Pirelli in Europe and Kyoritsu Maintenance in Japan. The same names also added to relative gains, as did US electric vehicle maker Rivian and the off-benchmark position in food delivery platform Just Eat. In Communications, the US positions in Spotify, Live Nation, Sea Ltd and the options position in Netflix rose the most, with Spotify and Netflix the main relative contributors. Netflix shares rose almost 10% in January after recording more than 300 million paid subscribers as of Q4 2024, an increase of almost 20 million users versus the previous quarter. We increased exposure to Spotify post the DeepSeek turbulence.
Technology was unsurprisingly more of a mixed bag. As the DeepSeek news broke, the Fund was overweight the full spectrum of AI themes: Phase 1 (builders), Phase 2 (infrastructure/value chain), Phase 3 (adopters, users, creators who can monetise AI usage) and also other indirectly related convictions (beneficiaries of increasing power demand such as Utilities, datacentres and high-performance computing (HPC)). We switched out of some enablers (we reduced exposure to TSMC), did not change the value chain exposure, allocated more to Phase 3 and added to software (Datadog, Snowflake and Spotify, plus a new position in Salesforce). We reduced some datacentre REIT exposure (Digital Realty) and maintained our overweight in quality names which will benefit from broader secular trends (e.g. Schneider in the Industrials space). We did not alter the HPC exposure where the sell-off appeared to us to be overly punitive. Software did well (Snowflake, Zscaler, Akamai, Xero, Nutanix, Guidewire), as did infrastructure (SK Hynix, Delta Electronics). Some hardware names (Lenovo, Quanta Computer) fell. In relative terms, the option positions in TSMC and Salesforce detracted, as did the off-benchmark position in Applied Digital and the overweight in Lenovo. The off-benchmark position in SK Hynix, the overweights in Nutanix, Seagate, Datadog and Zscaler, the position in Guidewire and new issue Delta Electronics all added to relative performance.
The performance in Industrials was spread across a number of sub-sectors. Uber Technologies added 0.1%, airlines IAG and Cathay Pacific gained, as did defence and aeronautics names Safran and MTU Aero Engines. In business services, RELX Plc and Bureau Veritas contributed, and in engineering and electrical equipment, Spie SA and Schneider Electric also rose. The US airlines (American Airlines, Southwest Airlines, JetBlue) and Singapore Airlines fell, as did renewable energy equipment maker Fluence Energy. An American Airlines passenger jet was involved in a fatal accident with a military helicopter outside Washington DC, causing the stock to sell off sharply.
OUTLOOK
After a strong year for the asset class in 2024, we forecast positive returns for convertible investors in 2025. Convertibles provide a bridge between the equity and fixed income worlds – they help to mitigate timing risk as they offer exposure to both and offer long-term optionality on names where the equity story is still unfolding, which is important in the current growth environment. Our base case is still for a soft(ish) landing, which would mean a contribution from equities, volatility (slightly higher overall volatility, but specifically periodic spikes as we saw in 2024), lower short rates, spreads unchanged and a benign default environment – a supportive backdrop for convertibles.
In terms of themes for 2025, we see performance potential for convertible bonds from: embracing growth, increased cryptocurrency adoption, increasing electricity demand, a positive geopolitical shift (more Chinese stimulus, America-fFirst, lower rates in Europe, increasing capex), consumer strength (strong labour markets, lower rates, energy prices are contained) and the upside from higher M&A and performance broadening to smaller and mid-sized names, which are well represented in the convertible bond universe.
