investment viewpoints
Convertible trendwatch: the recovery candidates
This paper forms part of a series exploring thematic shifts in convertible bonds driven by the pandemic, the recovery and longer-term structural trends.
The economic recovery from the pandemic is building and we detect some sectors that stand to benefit from the growing revival that will accompany the rollout of vaccines. The convertible bond asset class currently offers substantial exposure to companies that we believe will gain directly from a return to normality. We have dubbed these the recovery candidates.
Last year’s record issuance expanded the convertible asset class by 35% in 12 months, with a significant number of new issues coming from high growth themes such as digital consumption or work moving online.
There was also considerable new borrowing from companies that were among the worst-hit by the pandemic. These companies were defined by a sharp drop in earnings due to lockdown measures, and broadly shared the trait of having high fixed costs. Included in this trend were airlines and aerospace, cruise companies, travel specialists, clothing retailers, department stores, casinos and restaurant chains. Such issuers opted for bond borrowing to shore-up their balance sheets, and therefore “bridge” their cash requirements in order to remain financially viable until the global economy re-opened and business resumed.
The recovery theme forms the largest part of our global convertible bond strategy, representing approximately a quarter of the overall equity sensitivity.
As that re-opening accelerates in 2021-2022, we note that the sectors typically expected to benefit from a recovery are well represented in the convertible asset class. These sectors include industrials, consumer goods and services linked to in-person consumption.
Indeed, the recovery theme forms the largest part of our global convertible bond strategy, representing approximately a quarter of the overall equity sensitivity.
Mobility, travel and leisure
We believe companies involved in mobility, the travel industry and leisure are good recovery candidates as personal movement begins to resume. Here, we would concentrate on trends in selected names such as airlines, travel and tourism information technology, aircraft manufacturing and cruise companies. Our approach focuses on best-in-class names, avoiding the weakest companies in terms of credit, or those that appear likely to need further rounds of financing.
As economies re-open, we expect significant pent-up demand in services linked to these areas because consumers are eager to book flights or entertainment as soon as possible. We note this enthusiasm to reserve is reflected in spending trends on websites where traffic has increased significantly, as shown below. Airlines and travel bookings both began showing a net increase year-on-year in mid-March.
Source: Facteus, Goldman Sachs, LOIM. For illustrative purposes only. Refers to year-on-year change in US consumer spending and transactions on airlines and on travel bookings in the week to 03 January 2021 and the week to 14 March 2021.
We believe such demand could support airlines. In travel names, there has been a strong increase in Google searches for online accommodation such as Booking.com, Expedia and VRBO (which belongs to Expedia)1. App downloads for these companies have risen sharply.
Sources: LOIM, Goldman Sachs, Google search data from Google trends (year on year percentage change for week ending 17 Jan 2021 and week ending 14 March 2021). For illustrative purposes only. Any reference to a specific company or fund does not constitute a recommendation to buy, sell, hold or directly invest in the company or funds. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the funds discussed in this document.
Travel searches are typically conducted online, meaning travel and lodging companies use digital advertising to reach consumers. As such, we also favour social media companies to tap into this ad spend and diversify the overall exposure within the travel sector.
Elsewhere, US consumers have also increased their spending on lodging, according to recent data to mid-March 2021, potentially underpinning companies catering to holiday accommodation, in our opinion.
Sources: LOIM, Facteus, 2020 vs 2021 year over year weekly percentage increase, 03 January to 14 March 2021. For illustrative purposes only.
A broader scope for convexity
We broaden our scope beyond airline operators to the aerospace industry, including parts manufacture and maintenance. By including such derivatives of travel we aim to add convexity to the strategy by taking advantage of the opportunities available in the convertible universe specifically. By convexity, we mean the asymmetric properties inherent in the asset class that provide potential defensive properties2 from the bond element, as well as participation in potential upside from the equity element. This profile has led convertible bonds to offer superior risk-adjusted returns than traditional equities in the past3.
One example is Safran1, an aerospace parts supplier and maintenance provider. The company offers solutions to civil and military airframers as well as airlines, and is active in the engines, aircraft interiors and equipment markets. The company has more diverse exposure to both government contracts as well as to the general industry.
Lifestyle and luxury goods
Macroeconomic conditions at this phase of the pandemic favour the consumption of luxury and lifestyle goods, in our view. Households have accumulated savings, for instance, and lifestyle restrictions are driving purchases of physical goods. As lockdown measures are progressively lifted on events, we see sporting goods as a promising area.
Sporting goods could see greater demand as the reopening of the economy brings back not only championships and professional team sports, but also individual sports such as marathons etc. We expect consumers to actively participate in this revival, for example by buying outfits, shoes etc. A survey by Deloitte4 found that more than 60% of fans agreed that having a great “year-round experience” would make them more likely to become more engaged with their team in the coming season, while 55% said that it would make them more likely to purchase a ticket in the future.
Sources: LOIM, McKinsey and the World Federation of Sporting Goods Industry. For illustrative purposes only.
Sporting goods brands able to deliver greater marketing and an innovative product pipeline will be poised to outperform, in our opinion, as they are better positioned to capture stifled consumer demand. We believe that the desirability of brands is key to determining performance gaps between different names, rather than appetite for various product categories. One possible risk for international sporting brands currently stems from the dispute regarding the use of Chinese cotton. While we are closely monitoring the situation, we believe the issue is short-term and will not impact the long-term or overall rationale for investing in such brands.
Strong brand names, and the best retail partners of these brands, should thrive thanks to superior levels of investment in marketing and innovation, in our opinion.
Strong brand names, and the best retail partners of these brands, should thrive thanks to superior levels of investment in marketing and innovation, in our opinion.
In the luxury market, we favour companies with varied exposure because this increases the resilience of their business. Having diverse commercial areas helps balance out the impact of the pandemic, and offers additional convexity advantages.
For instance, last year LVMH’s1 fashion and leather goods segments fared well despite the pandemic. Other areas, such as perfumes/cosmetics and retailing, have been heavily impacted by Covid-19 restrictions but are expected to rebound once the economy reopens and tourism flow normalises. As such, we believe the name is not overly exposed in a single segment, thereby boosting its resistance.
From mobility to travel, and lifestyle to luxury, we believe the recovery candidates are poised to benefit from the trends shaping today’s world.
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