Global growth spurs convertible bonds opportunities, strong issuance may be ahead

26/04/2018

• Convertible bonds have outperformed equities and bonds over the long term • NN IP anticipates two economic scenarios in which interest rates will increase and economic growth will either remain range-bound or break out on the upside, supporting the case for convertible bonds. • NN Investment Partners (NN IP) expects monetary tightening and higher bond yields to prompt greater issuance of convertible bonds

Convertible bonds (CBs) have generated equity-like returns with much lower volatility over the long term, reveals analysis[1] by NN Investment Partners (NN IP). The analysis underlines that over the 20 years until March-2018, CBs have outperformed equities, global corporate bonds and global government bonds.

NN IP anticipates two possible economic scenarios in which interest rates will increase and economic growth will either remain range-bound or break out on the upside. Jasper van Ingen, Senior Portfolio Manager at NN Investment Partners explains below why CBs offer outstanding tactical investment opportunities in both scenarios.

Van Ingen expects monetary tightening and higher bond yields will prompt greater issuance of convertible bonds. He comments: “CBs have generated equity-like returns with much lower volatility over the long term, making them an attractive addition to many investors’ portfolios. As we look ahead, rising rates and bond yields are likely to incentivise companies to issue CBs as a means of saving on interest expenses, improving market dynamics and widening the pool of investment opportunities.”

Asymmetric return profile

An important feature of CBs is their asymmetric return structure: they capture equity upside while protecting against the downside. Over the economic cycle, CBs capture 30-60%[2] of the performance of their underlying equities. This asymmetry generates a positive relationship with volatility. Van Ingen says: “The asymmetric return profile means that all else being equal, a CB benefits more from an increase in the underlying share price than it loses from a decline of similar magnitude. This attractive characteristic means that higher stock volatility is good for CBs.”

High credit quality, low default rate

CBs present an attractive risk profile, with the average credit quality of the balanced CB universe currently at BBB-. In times of stress, the default rate of the CB universe is much lower than that of high yield bonds. For example, in the 2008 financial crisis, the CB default rate peaked at less than 3%[3].

Correlation and diversification

Like equities, CBs have a negative correlation to government bond returns (-11% over the past 20 years[4]), while the correlation between CB and equity returns is high (87%), providing protection for investors during times of increasing Treasury yields. Indeed, CBs showed strong positive return during the last significant rise in Treasury yields - the “taper tantrum” of May-September 2013 - when five-year Treasury yields increased from 0.71% to 1.60%[5].

CBs’ limited correlation to other traditional asset classes makes them a valuable diversifier, increasing a portfolio’s expected risk-adjusted return.

Gains from M&A and other corporate activity

CBs typically have in-built protections that allow investors to benefit in the event of corporate takeovers. Investors can be rewarded both through an increased share price following a transaction and through change-of-control protection features often built into them.

Van Ingen concludes: “We believe CB’s represent an interesting investment opportunity going into 2018 and beyond. The asset class combines several characteristics that may prove very valuable: a low effective duration, moderate correlation to other asset classes and participation to equity markets that are supported by growth expectations”.

Sources:
[1] Bloomberg, NN IP analysis, 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
[2] Data from Thomson Reuters, NN IP analysis, April 2018
[3] Data from Thomson Reuters, NN IP analysis, April 2018
[4] as of end of March 2018 using 243 months of data (20 years, 3 months)
[5] Bloomberg, 2018

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Disclaimer

This communication is intended for press use only. This communication has been prepared solely for the purpose of information and does not constitute an offer, in particular a prospectus or any invitation to treat, buy or sell any security or to participate in any trading strategy or the provision of investment services. While particular attention has been paid to the contents of this communication, no guarantee, warranty or representation, express or implied, is given to the accuracy, correctness or completeness thereof. Any information given in this communication may be subject to change or update without notice. Neither NN Investment Partners B.V., NN Investment Partners Holdings N.V. nor any other company or unit belonging to the NN Group, nor any of its directors or employees can be held directly or indirectly liable or responsible with respect to this communication. Investment sustains risk. Please note that the value of any investment may rise or fall and that past performance is not indicative of future results and should in no event be deemed as such. This communication is not directed at and must not be acted upon by US Persons as defined in Rule 902 of Regulation S of the United States Securities Act of 1933, and is not intended and may not be used to solicit sales of investments or subscription of securities in countries where this is prohibited by the relevant authorities or legislation. Any claims arising out of or in connection with the terms and conditions of this disclaimer are governed by Dutch law.

About the author

Jasper van Ingen

Jasper van Ingen

Senior Portfolio Manager

Experience since 2002

Business Experience

2014-to date Senior Portfolio Manager Convertible Bond
Jasper is Senior Portfolio Manager Convertible Bond Strategies at NN Investment Partners

2013-2014 Partner/Senior Portfolio Manager, Avoca Convertible Bond Partners LLP, London

2011-2013 Senior Portfolio Manager Convertible Bond Strategies, Avoca Capital, London

2010-2011 Partner, Project 8IM, London

2008-2010 Senior Portfolio Manager, Corporate Opportunity Strategies, APG Asset management, Amsterdam

2004-2007 Portfolio Manager, Corporate Opportunity Strategies, APG Asset management, Amsterdam

2003-2004 Portfolio Manager, Hedge Fund Strategies, ABP Investments, New York

2002-2003 Portfolio Manager, Hedge Fund Strategies, ABP Investments, Amsterdam

Qualifications
MSc, Finance, University of Amsterdam, 2001

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