Convertible bonds bonanza creates theme-based opportunities for investors
The coronavirus crisis has led to a surge in convertible bonds on the market, with second quarter issuance exceeding USD67 billion as opposed to an annual average of USD100 billion over the past decade.
According to NN IP, convertible bonds are an attractive option in times of heightened uncertainty, with volatility likely to remain high. Particular opportunities have opened up in cybersecurity, healthcare spending growth, cloud computing, and electrification and batteries themes, says NN IP.
A convertible bond is a bond plus an embedded stock option, giving features of fixed income and equities in one instrument. These equity/fixed-income hybrids offer the best of both worlds: their conversion option gives exposure to the upside in share prices, and their bond cashflows provide downside protection should the underlying share price fall.
The market has certainly responded to the potential merits of convertibles. NN IP notes a sharp rise in issuance of convertibles over the past quarter. Issuance was USD16 billion in April, USD27 billion in May and USD25 billion in June, amounting to more than USD67 billion in total.
This is about two-thirds of the annual average over the past decade of around USD100 billion.
The reason for the new issuance has to do with the fact that convertibles offer a cost-effective and flexible way for companies to raise capital, either to remain operational or to take advantage of new business opportunities. The current volatility in equity markets means it is also often more attractive than a share issue; the lower coupon rates for convertibles make the running costs much cheaper than those for straight debt.
Martin Haycock, senior convertible bonds specialist at NN Investment Partners, says that around a third of recent issues relate to companies that are in trouble because of the current crisis, such as travel companies, while the majority of issuers are looking for capital to finance growth.
“We are interested in this latter group, which includes companies involved in cybersecurity, cloud computing, batteries/electrification and healthcare, which will see growth in the next three to five years,” says Haycock. “This is why it is crucial to take a thematic approach to navigate economic cycles and invest in the right convertibles.”
Tarek Saber, head of convertible bonds at NN Investment Partners says a convertible bonds bonanza is underway, as more and more companies see the benefit of issuing convertibles in the post-coronavirus world.
“This is a positive for the asset class and a growing number of investors are embracing the unique historic risk-return characteristics of convertibles and allocating a place for them in their strategic asset allocations,” says Saber. “We would recommend allocations of between 3 per cent and 10 per cent, depending on investors’ appetites. Whatever they choose, they should partner with investment managers who are strict in their investment process and won’t buy new issues just because they might be theoretically cheap at issue, but instead focus on the credit and equity fundamentals of the issuer.”