Convertible bonds currently appear fairly defensive relative to history with valuations looking particularly attractive in Asia.
18.12.2018 | 13:42 Uhr
October 2018 clearly reminded equity investors of the risks in stock markets. After a prolonged period of abundant positive returns and low volatility, macro and political risks are again forefront of investors’ minds:
All these risk have one thing in common: they are known – and in fact have been around for months if not years.
2018 marked a special occasion: the US equity market saw two set-backs of 10% losses for the first time since 1960. While history tells us this is unlikely to repeat next year, the easy part of any outlook for 2019 is to state that volatility will remain high.
Central banks are moving away from quantitative easing to a process of gradual tightening. The US Federal Reserve (Fed) has hiked eight times since late-2015. The likelihood is this will weigh on demand for bond investments. In addition, US companies will slow down their stock buyback programmes. In 2018 US businesses moved a vast amount of money back to the US due to incentives under the tax reform. This will slow down in 2019. Together these shifts could result in a buyers’ strike for bonds and equities and a serious shift in the demand and supply ratio.
Amid this changing backdrop, we see scope for convertible bonds to continue to assert the following core characteristics:
In general, the degree of possible protection from convertible bonds depends on several factors: the amount of equity exposure, the distance to the bond floor (the safer fixed income element of convertible bonds), the credit risk or estimated risk the company will default and valuation.
The convertible universe currently exhibits notably protective characteristics compared to history. The overall equity exposure sits at a low 36% with a high 88% bond floor, the fixed income value of the convertible bond. Assuming the issuer survives and pays back at maturity, this is the protective element for the capital invested, and theoretically, the lowest market value the security can fall to. The overall credit rating is a stable BBB+ average (Thomson Reuters Global Focus Index) suggesting these companies can weather more difficult conditions.
Crucially, the asset class is fairly-priced. The rich valuation levels in the US and in Europe have come down significantly while Japan and Asia ex Japan continue to offer discounts to fair value.
Valuations of convertible bonds
Finally, the market structure has changed following summer 2018 primary market issuance. Previously lacking interesting disruptive business models, the universe now offers highly balanced names with a dynamic growth tilt. IT remains the dominant sector, particularly cloud businesses, app services, and payment solutions providers. With the October set-back, many of these structures are trading much closer to par value with significant upside.
Given the current fundamentals of convertible bonds, we think the investment question for 2019 may not be whether to have an allocation to the asset class, but how much to allocate.
Die hierin geäußerten Ansichten und Meinungen stellen nicht notwendigerweise die in anderen Mitteilungen, Strategien oder Fonds von Schroders oder anderen Marktteilnehmern ausgedrückten oder aufgeführten Ansichten dar. Der Beitrag wurde am 16.12.18 auch auf schroders.com veröffentlicht.
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