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Global convertible bonds in today's manic markets

Global convertible bonds in today's manic markets

The global convertible bond market performed as expected over the last six months, benefiting on one hand from generally positive equity markets while being hampered slightly by rising rates.

During the highly volatile market period of the first months of 2018, the convertible bond market did not see unexpected dislocation, as convertible bond investors stayed well behaved, according to Citywire A-rated manager Alain Eckmann.

Eckmann co-manages the UBS (Lux) Bond Sicav – Convert Gl (EUR) Pa fund with Citywire A-rated Ulrich Sperl, a fund that has been ranked top of the global convertibles bond category for risk-adjusted returns over the past three years with a rate of 13.06%.

Although the global primary market for convertible bonds has been very active over the last six months, investors had to be extremely selective regarding which new issue to buy, as some were issued on an opportunistic basis with grossly inflated valuations, Eckmann said.

‘Currently, we see slightly more opportunities in the US, Asia and Japan than in Europe. Our equity sensitivity is slightly higher than the market and our duration slightly shorter,’ he said.

Eckmann said the fund’s performance comes from the equity and credit sides, as well as from bond-specific activities –  including bond valuations, prospectus features, bond restructuring, and takeover ratchets –  among others.

Second place in the risk-adjusted ranking is the Franklin Global Convertible Securities A (acc) USD fund, managed by Citywire A-rated Alan Muschott and Citywire + rated Matt Quinlan. The fund has pulled ahead of the average manager with a 16.68% return over the past three years.

Muschott said the convertible securities market had positive results in the fourth quarter of 2017 that lagged behind the equity market’s overall advance by a significant margin. However, it generally fared better  in 2018’s first quarter in the face of the equity market’s overall decline.

Performance within the universe varied as equity-sensitive convertibles had the best overall returns, topping a much smaller average gain for balanced convertibles and a shallow overall decline for “busted” convertibles.

Sectors such as information technology and healthcare were the strongest performers, Muschott said.

‘We believe investors might be increasingly drawn towards convertible securities this year, particularly as US interest rates look set to rise further and many global uncertainties remain, including the potential for mounting geopolitical and trade-related tensions,’ he said.

Muschott said he also expects to see an environment supportive of equity markets, driven by a general shift from expansive monetary policy to expansive fiscal policies, and not just in the United States.

‘Our strategy is focused on balanced convertibles – those that tread the middle ground in terms of their equity sensitivity,’ Muschott said.  

‘While this type of convertible does not participate dollar for dollar in strong equity rallies, it tends to offer greater upside participation than downside potential, leading to an asymmetric, favorable risk/return profile,’ he said.

Over full market cycles, balanced convertibles have performed well relative to both broad equity and fixed income markets on a risk-adjusted basis, he added.

Muschott said convertibles’ performance is largely a reflection of the performance of the underlying convertibles issuers.

‘Because of this, we focus on fundamental in-house research of the issuers with a goal of identifying companies with unique competitive advantages that should allow sustained above-average growth in earnings and revenues over a three- to five-year time horizon,’ he said.

He added: ‘We typically seek companies with strong long-term earnings, asset value, and cash flow potential.’

Making hay while the sun shines

The NN (L) Global Convertibles Opps I Cap USD fund, co-managed by Tarek Saber and Jasper van Ingen, came fourth in this category. Both managers are Citywire + rated.

The fund returned 14.22% over the past three years compared with a sector average of 8.62%.

Saber said the first quarter of 2018 led to the largest number of issues since 2007 and the second highest by value since 2007.

Rising rates and volatility make for fertile ground for convertible bonds issuance, he said.

The fund’s convertible strategy benefits from secular trends, of which there are plenty in 2018, Saber said.

‘We forecast a faster-than-expected pace of US interest hikes, inflation could surprise on the upside and markets will remain volatile, making convertibles a good choice,’ he said.

Saber said the fund takes a medium term view of between 18 months and three years and do not manage for risk on or off.  

All holdings are currency hedges and the fund only invests in convertible bonds with no overlay, he said.

Currently, the fund’s portfolio is 95% invested into 18 active investment themes and 36 convertible bonds.

‘We continue to be invested in a portfolio of convertible bonds that have solid credit fundamentals and either attractive equity upside, an attractive yield, or both,’ Saber said.

‘We remain positioned “credit cautious” with our strategies’ credit profile and duration slightly more defensive than the market, and slightly overweight equity exposure, mainly in the US and Europe,’ he said.

The article was published in the June issue of the Citywire Private Wealth magazine.

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Jasper van Ingen
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15/93 in Bonds - Convertibles Global (Performance over 3 years) Average Total Return: 11.28%
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