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FE Adviser Fund Index

Since the onset of the financial crisis, conviction has been a rare commodity in the investment community. In such an uncertain environment the appeal of convertible bonds could see a resurgence.

Convertibles are in effect bonds that can be converted into a specified number of shares in the issuing company. This means they offer a yield component, albeit a lower yield than straight corporate bonds, with the potential to gain exposure to rises in the share price.

Traditionally, large institutions such as pension funds, wealth managers and hedge funds have dominated the convertibles market. However, after the forced selling in 2008, hedge funds play a much smaller role and, with some of the leveraged players gone, many view the market as more stable.

The main appeal of such a structure is that it offers downside protection as investors have the option, but not the obligation, to convert their bonds into equity. For markets where investors are looking to gain equity exposure but are unsure about when to dip their toes in, this could be seen as offering a solution.

For retail investors, the question is whether products that by their very nature are unlikely to appear at the top of any performance chart can tempt them.

Among FE Adviser Fund Index panelists there are still some lingering doubts over the asset class.

Whitechurch Securities head of research Ben Willis says: “It is an area that I have looked at in the past, but it has not been one that we have allocated to. It gives you a half-way house between equities and bonds, which could come to the fore in the current environment. The problem is that I have never known a group to promote them.”

The reluctance to build a marketing fanfare around them is understandable. Unlike the clamour for hedge fund-type products that saw long/short strategies creep into the retail market, little noise has been made about convertibles. Indeed, many advisers may view a properly diversified portfolio as offering a similar risk profile as these products claim to do.

The five-year returns from the IMA global and IMA global bonds sectors present a fairly stark picture. Between June 22, 2007 and June 22, 2012, the average fund in the IMA global sector lost 1.25 per cent for investors, while the average global fixed income portfolio returned 45.28 per cent.

The reasons for the outperformance of fixed income relative to equities have been well documented. Nervous investors have begun to question whether bonds can still offer an element of capital protection and if it will be equities, not bonds, that lead the way in the next stage of the recovery.

Although the asset management industry seems unwilling to push convertibles, with the rise of strategic bond funds it is likely retail money is finding its way into the asset class. The IMA defines the sterling strategic bond sector as: “Funds which invest at least 80 per cent of their assets in sterling denominated fixed interest securities. This includes convertibles, preference shares and permanent interest bearing shares.”

According to UBS index data, the total convertibles market is worth in the region of £322bn. With an average maturity of five years, companies have to issue some £63.7bn of new bonds every year to maintain the present size of the market.

Last year, however, only £38.2bn worth of convertibles were issued, while this year is on course for about £31.8bn.

Yet if interest rates do start to creep up and equity markets break free from their current malaise, the appeal of convertibles should track both upwards.

Data supplied by FE


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