investment viewpoints
Convertible high conviction: growth and asymmetry
In this question and answer, Co-Head of Convertible Bonds Natalia Bucci discusses why a strategy focused on growth suits today’s investment backdrop and how the asymmetry of the asset class could prove useful from a volatility perspective.
Why did you join LOIM last year?
As a specialist in convertible bonds, LOIM was a natural fit for me because the convertible franchise is at the centre of the business. There is a clear spotlight on the asset class here: it is given the full gambit of resources and attention, and all of the means necessary to fully exploit its potential.
I was also keen to join a company that has enjoyed strong expansion over the past 15 years, and simultaneously focuses on a sustainable future. I felt that LOIM’s ethos around sustainability aligned with my own, personal principles. I enjoy working here because we fully incorporate sustainability into our mindset and investments via a robust and thorough method.
watch our video to learn more about our approach.
What is the rationale for the convertible team’s new high conviction strategy1?
The strategy invests in our highest conviction names in global convertible bonds, aiming to generate superior performance through a more flexible approach to risk2. This means creating a portfolio of around 50 companies selected for their high return potential, with broad but supple diversification among regions and sectors.
The investment backdrop of ultra-low rates currently favours risky assets and the focus is on potentially high growth companies. These names are expected to benefit from trends in the new economy as well as the selection of securities in lower growth sectors.
Our strategy enables investors to tap into these prospects, with the distinctive asymmetric characteristics of the asset class. We expect possible spikes in volatility due to the uncertain environment left by Covid-19, as well as more general macroeconomic and geopolitical risks. Convertible bonds have historically outperformed traditional equities during volatile periods on a risk-adjusted basis3. The asymmetric return profile of convertible bonds means they typically provide more upside potential than downside risk, and the asset class is recognised as a provider of higher Sharpe ratios than conventional equities in the past.
What expertise did you bring that could benefit a high conviction strategy?
During my career managing convertible bonds, I have overseen multiple strategies that aim to give investors an equity proxy that simultaneously could level out the volatility element. Our high conviction strategy taps into this experience because the strategy focuses on a more aggressive approach with fewer constraints. We put growth at the centre of the investment rationale, considering each investment on the basis of the fundamentals of the potential equity upside and balance sheet strength. These two aspects are crucial in a high conviction strategy because the upside potential is the first and main criteria to select names.
Convertible bonds are an effective way to gain exposure to more volatile, high growth companies while potentially improving Sharpe ratios over equities, in my opinion. Such companies typically have unpredictable share prices due to the low visibility of their cash flows and/or profitability, combined with high valuations. This could cause their share price to fluctuate significantly, for instance, if results surprise expectations. By investing in convertibles, however, the equity option enables investors to partake in the equity upside but the bond element could also act as a buffer to the downside4.
How has the pandemic changed the asset class and how could a risk-on strategy benefit from those changes?
The asset class has grown exponentially over the past year thanks to a surge in new issuance from companies financing their development through convertible bond borrowing. Many of these companies stand to benefit from pandemic-driven policies that require people to stay home, and they operate businesses that we define as disruptive: online grocery deliveries, home fitness, ecommerce etc.
We believe these disruptive businesses will develop further in future, and new companies will emerge to challenge them. New entrants are also expected to use convertible bond issuance to fuel their expansion. A high conviction strategy gives investors the opportunity to gain exposure to these thematic trends as they emerge, consolidate and evolve.
What type of resources can you leverage to manage this strategy?
LOIM manages EUR6bn of convertible strategies globally, with offices in Geneva, London and Asia. Our immediate team is comprised of 11 specialists dedicated to all aspects of convertible bonds. In addition to our expertise in pure convertibles, we are also supported by a larger LOIM team of 8 additional equity analysts, 7 credit analysts and 2 risk managers, all of whom provide further resources on the more specific components of the asset class.
As for tools, we have access to a proprietary LOIM equity research platform that combines DEER (Discounted Excess Economic Returns) and ESG (environmental, social and governance) information.
We further leverage sustainability intelligence from a 20-strong team of sustainability and ESG experts. Their expertise and bespoke set of tools are used to fully integrate ESG and sustainability factors into our decisions.
What is the team’s approach to sustainability?
Our global convertible strategy, LO Funds – Convertible Bonds, was one of the first (and few) to achieve Febelfin’s Towards Sustainability label in October 2020. The labelling followed a six-month audit of our process and portfolio by the Central Labelling Agency (CLA), which monitors the quality standard for sustainable and socially responsible financial products5.
We take a multi-pronged approach to sustainability involving exclusions, screening, integration of non-financial data and engagement. Our investment process excludes certain controversial activities from our investment universe such as those companies involved in:
- UN Global Compact controversies
- Non-conventional weapons
- Tobacco
- Unconventional oil and gas extraction
- Coal extraction
- Excessive carbon intensity (>408gCO2/kWh)
We then screen investments based on international norms and standards and integrate non-financial criteria in a highly active selection process. We generate proprietary ESG materiality scores, measure temperature alignment and exposure to controversies. The LOIM ESG materiality framework goes beyond simple scoring to recognise which data matters most to each industry. We believe this is more valuable than relying solely on external aggregated ratings as it helps identify companies making genuine progress towards more sustainable business practices.
Lastly, the convertibles team is committed to accelerating engagement with poorly-rated convertible bond issuers, in close collaboration with the ESG and stewardship teams of LOIM, to continuously identify candidates for further engagement
In a nutshell, how would you describe the high conviction strategy?
A risk-on strategy for growth that maintains the asymmetry aspects that convertible bonds are known for.
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