Parts of the convertible bond market are overpriced, and investors should avoid companies that deal in 'reverse arbitrage'.
That's the view of Ulrich Sperl and Alain Eckmann, who manage the UBS (Lux) Bond Sicav – Convert GI and UBS (Lux) Bond Fd-Convert Europe funds. The Citywire + rated managers said some investors were making mistakes by buying bonds that were too expensive.
‘You see some herding in our market. Many people have an investment grade focus and are buying bonds that are just in the main indices,’ Sperl told Citywire Selector.
‘If you combine these two themes you have a bond that is investment grade, liquid enough and big enough to be in the main indices – there is a pretty good chance that these bonds are quite expensive.'
The manager added that well-known blue-chip liquid European companies were positioning themselves so that the average manager could easily buy the bonds they issued.
‘These companies are intentionally coming to our market to issue expensive bonds and simultaneously buy back cheap options against it. Basically they do reverse arbitrage in our market.
‘It is a big theme in our market and something that is very important to handle in a disciplined way. These bonds can become attractive at a later stage in time, for whatever reason. But at issue they often quite unattractive.’
Process of elimination
A recent poll taken at Citywire Amsterdam Forum 2017 showed that investors were avoiding convertible bonds. Commenting on the results the managers said that the asset class still holds opportunities for investors over the long term.
‘If we look at the converts market currently, it is not especially cheap based on its history. This is therefore not a particularly good point in time where you would invest in convertibles except if you do it for long term strategic reasons. This leads us to the conclusion that people act by elimination,’ Eckmann said.
‘If you look at the asset classes, some people might avoid bonds with the current low yield levels. Equity markets have risen and they might become fragile if Fed normalization goes on.
'By eliminating one asset class after the other, if you want to stay invested this leads you to converts. If you look at market valuations, it does not support the argument that there is a specific opportunity window currently active.’
Over three years to the end of August 2017 the UBS (Lux) Bond Fd-Convert Europe fund returned 2.07% in euro terms. This compares to a fall of 0.48% by its Citywire-assigned benchmark the ECI-Europe over the same time frame.
Meanwhile, the UBS (Lux) Bond Sicav – Convert GI fund returned 0.81% in US dollar terms over three years to the end of August 2017. This compares to a fall of 0.84% by its Citywire-assigned benchmark the Thomson Reuters Global Convertible EUR hedged over the same time period.