Jasper van Ingen, Senior Portfolio Manager Convertible Bonds
Current rising yields present a strong incentive for corporations to issue convertible bonds that typically pay lower coupons. This has resulted in a significant increase in the volume of new issues of CBs. The phenomenon can largely be attributed to the rising interest rates in the US as a large part of the new USD CBs have been brought to the market to refinance high yield and investment grade bonds. In fact, US convertible issuance has totalled at 36% of US high yield issuance year-to-date compared to just 16% in 2017. Notably, over 50% of the new issues have been from first time issuers, which is a record high and shows the significant expansion of the investment universe. Global issuance is likely to remain strong going forward, driven by the US but also by Europe where a similar trend is likely to emerge following the end of the ECB bond buying programme.
CBs unique positioning between equities and bonds
Analysis1 shows that the CB asset class has outperformed equities over the last 20 years with 35% lower volatility, highlighting the potential added value of CBs to investor portfolios. CBs can also be a powerful diversifier within portfolios, due to their high correlation to equities, but limited correlation to high yield bonds and even negative correlation with government bonds. The analysis shows that CBs have displayed an 85% correlation with equities over the last 20 years but lower figures of 71% and 39% with high yield and investment grade bonds respectively. They showed a negative correlation of -11% with government bonds.
Jasper van Ingen, Senior Portfolio Manager Convertible Bonds at NN Investment Partners explains: “Equities’ and CBs’ outperformance of fixed income in a rising rate environment is a fairly consistent pattern dating back to the 1980s. In times of rising rates, equities have historically performed well as interest rates have risen to counter economic overheating, thereby boosting CB returns. At the same time, CBs are less affected by rising rates than non-convertible bonds due to their lower duration. Rising rates also provide a strong incentive for companies to issue CBs as the coupon rebate that issuers receive becomes more material. This also gives more choice to investors. As such the strong positive momentum in global CB issuance in 2018, the highest since 2007, is no surprise.”
Theme-based approach
At NN Investment Partners, the convertible bond investment team uses a theme-based framework to identify attractive medium-term investment opportunities. At present, Van Ingen sees several key themes offering strong potential in the CB market, including Electronic Components, Healthcare Spending and Cloud Computing. He believes these themes will benefit from an increasing demand for electronic devices with ever more components to increase their functionality, for healthcare-related services to cater for the increasing population that is capable of affording such services, and for cloud data storage.
“We are closely following a number of events and possible risks in the coming months, including Brexit, a potential further escalation of the trade war and a possible resurgence of geopolitical tensions. As such, it is important to construct a portfolio that can weather market disruptions by selecting CBs with strong credit fundamentals.”
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1Source: Bloomberg, NN IP analysis 20 years to 31 July 2018, Thomson Reuters Global Convertible Bond Index, MSCI World, BoAML Global Broad Market Corporate Index, BoAML Global Government Bonds Index, all in USD, hedged after 10/2002.
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