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Are convertible bonds attracting investor interest?

Advisers and fund managers share mixed views when it comes to investing in convertible bonds.

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Advisers and fund managers share mixed views when it comes to investing in convertible bonds, which can give equity market investors the downside protection of a bond as well as equity-like participation in rising markets.

UBS estimates the global convertibles bond market was worth $500bn as at 15 April and the recent launch of the JP Morgan Asset Management Global Convertibles Income fund suggests there is a growing appetite in the market for convertibles.

Convertibles give investors bond-like income combined with the option to convert those bonds into stock if the company’s share price rises.

GAM investment manager Alex McKnight says convertible bonds issuance has been strong this year and convertibles are catching investors’ eye.

McKnight says after the strong performance of credit markets last year, there has been an increasing number of investors switching out of investment grade and high yield credit into convertible bonds, to take advantage of increasingly bullish markets.

He suggests an increase in M&A activity will impact positively on convertible bond performance this year as small and mid-cap convertible bond issuers with exposure to growth areas become attractive takeover targets.

McKnight says the case for investing in convertibles is strong because they provide the best of both worlds – “protection during periods of excessive volatility and the potential for robust returns from rising equity markets”.

JP Morgan Asset Management head of investment trusts Simon Crinage says: “Small and mid-cap stocks have lagged the FTSE in recent weeks and are also more vulnerable to sudden changes in sentiment, making convertibles in these areas an attractive choice for those whose optimism is tempered with caution.

“Convertible bonds from these smaller and mid-cap names tend to offer higher levels of coupon, making them attractive from a yield perspective as well.”

However, convertible bonds are not for everybody, particularly investors who do not like to sit between fixed income and equities.

F&C Investments multi-manager Gary Potter does not hold any convertible bonds at all and believes you are either in equities or in bonds, adding, “convertibles are a staging post for those sat on the fence”.

Potter describes investing in convertibles as “a bit of a halfway house” and a “soft option”.

Convertible bond issues

Breakdown of convertible bond issuance by region  
Region %
USA 45
Europe 25
Asia ex-Japan 16
Japan 6
Other markets 8
Source: UBS  

He says: “Convertibles is a bit of a soft option in my opinion. If you believe equities are doing better you might as well be in equities and if you like the coupon attachment there is the option of high yield or other strategic bonds or absolute bonds.

“We are paid to make decisions on equities and cash and just putting money into soft options is not what to do.”

Chase de Vere head of communications Patrick Connolly says he is negative on fixed income in general and agrees with Potter, believing convertible bonds defeat the objective of holding fixed income.

Connolly says: “Typically people are looking to invest in fixed interest either to generate an income or to diversify away from equity investment.

“Convertible bonds pay a lower level of income because effectively you sacrifice an income for the opportunity to convert into equity and in terms of correlation, convertible bonds will be more correlated to the equity market than other types of fixed income.”

Connolly does not include convertible bonds in clients’ portfolios.

He says: “We do not know how we can get good access to them or how they would fit or add value to a client portfolio.”

However, Skerritts Consultants head of investments Andrew Merricks is appreciative of the asset class.

He says: “There are not many convertible bonds out there. I am all for convertible bonds particularly in this environment where income is so hard to come by.”

Merricks highlights the £788.7m M&G Global Convertibles fund, the £443.5m Aberdeen Asian Smaller Investment Trust and the newly launched JP Morgan Global Convertibles Income fund as potential products for investors.

He says: “The only convertible bond we have in our portfolios is the Aberdeen Asian Smaller Investment Trust. Last year it looked like a good bet and since we bought it, the trust has gone up 28 per cent.”

Charles Stanley Direct head of investment research Ben Yearsley says he is indifferent to convertible bonds, describing them as a “niche” asset class.

He says: “The problem at the moment is where do they fit? You have straightforward bonds yielding 4 per cent investment grade, you have equities yielding 5 per cent – it depends where they actually fit in the structure.”

Hargreaves Lansdown senior investment manager Adrian Lowcock says if equities become favourable, convertibles could be an attractive option.

He says: “Convertible bonds was one of those areas that was expected to be popular after the financial crisis but it has taken time to come off.

“Convertibles used to be popular but stockmarkets went sideways over a 13-year period. It could be interesting for those who are looking at fixed interest but don’t want to miss out on the market rally.”

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