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Convertibles on the rise: top managers trade views

Convertibles on the rise: top managers trade views

Convertible bonds have risen from relative obscurity to be among the most sought after asset classes over the start of 2013.

Since the start of the year fund selectors have voiced increasing interest in convertibles, with attendees at Citywire Italy and Citywire Germany both backing the sector to outperform.

Here Citywire Global takes a closer look at drivers and challenges at play for fund managers.

Offering their expert opinions are:

Why the rise in popularity?

Shawn Mato, Aviva Investors

Other bond classes have experienced a bit of a wobble over the six weeks to the end of June, but we haven’t seen that as much in convertibles. Part of the strength for convertibles over this time has been the equity component.

The move to shorter duration is part of the reason the sector has done well, as we haven’t and are unlikely to see them getting beaten up as interest rates rise. In fact, as equities tend to perform well in a rising rate environment, so we are seeing improvements in earnings and multiples expansion.

Leonard Vinville, M&G

It’s a stockpicker’s market and this will contribute to long-term performance but the market remains in a good position overall to deliver solid asymmetric returns; participating well while equity prices rally but holding up better when they slip back.

Michael Reed, BlueBay

The level of interest we are seeing among high quality pension funds and asset allocators has been at its highest point in the 20 plus years I have been running convertibles funds.

There is certainly a demand for bond-like equities which convertibles can fill, as it will also provide equity participation. So we are entering a period where investors want to participate in the upside but also experience much lower volatility.

Verdict: Many macro factors have shaped an ideal environment for convertibles, according to the three managers. The low rate environment coupled with the need for income makes equity-like rather than straight equity products an attractive proposition in this climate.

How are you positioning?

Michael Reed, BlueBay

One of the areas that we see as positive in the second half is in bio-pharma and the medical sector, we are also looking at autos and we think there is some value in the emerging markets as well. It is largely consistent with what we saw in the first half, where the tech sector performed well.

Leonard Vinville, M&G

I look for investment opportunities amongst ‘balanced’ convertibles, those that lie in the sweet spot between ‘equity substitutes’ and ‘bond-like’ issues. These convertibles, termed ‘at the money’, generate the most asymmetric returns, where potential equity-driven upside exceeds the possible downside.   

Shawn Mato, Aviva Investors

This year we have seen, certainly over the first six months, that Japan has been very strong for us. We have been overweight there since last September and another area has been the US, where we are also overweight, and have seen strong performance in healthcare, for example.

Verdict: With $50 billion of issuance globally since the beginning of the year, there is certainly a large pool of investments to look through. The willingness of companies to refinance and issue provides deeper liquidity for a previously constrained market.

Where now for convertibles?

Leonard Vinville, M&G

Even if interest rates were to rise, convertibles are likely to be less sensitive than other corporate bonds because they tend to be relatively short-dated, usually having a term of between three and five years.

Also, the value of the call option embedded within convertibles increases as interest rates rise, thus mitigating the negative effect of higher rates.

Michael Reed, BlueBay

I think things that could reduce investor interest would be equities having a negative period, for example, if we see a slowdown in US economy or downgrades on earnings, then people would be more focused on high grade corporates instead.

Also, if we saw another blow up in the eurozone periphery that could be damaging for equity markets and lead to some reduced interest for convertibles. Those could, hypothetically reduce interest, but the demand among investors has been particularly strong.

Shawn Mato, Aviva Investors

I think demand has been very strong and will continue to be strong. We are on course for this to be the convertibles run for the next three-to-five years.

We have had a lot of debt refinancing and now companies are looking at having some equity-like issuance but not necessarily equity, so there are growth opportunities there.

Verdict: Major macro shocks could impact investor confidence but on the whole the low rate environment – which is projected to last at least until the end of 2014 – continues to foster a positive market for convertibles.

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