The global convertible bond market, which languished in the doldrums since the great financial crisis of 2008/2009, has staged something of a comeback over the past 18 months. This whitepaper explores the exigencies of this instrument, the reasons for its resurgence, and whether the trend will continue. Download Whitepaper
The convertible bond market picked up dramatically with the onset of COVID-19. The convertible became one of the only ways in which stressed organizations could raise desperately needed capital at a halfway acceptable cost. These notes found ready buyers as they were priced comparatively cheaply with high coupons and low conversion premiums.
As the economy bounced back surprisingly strongly in the second half of 2020, the convertible market was again popular with a new set of borrowers. These were names that had done well in the crisis and saw the opportunity to offer investors the chance to participate in their formidable stock rally.
Issuance boomed in 2020 and continued to do so in 2021 to levels not seen since before 2008/2009. At the end of November 2021, secondary market outstanding in the global convertible market was $509.5bn, according to investment bank calculations, of which 67 percent was held in the US. Issuance over the course of the year was $137bn.
Convertible arbitrage has also become popular again. It is estimated that arbitrage funds now constitute around 40 percent of the market while outright buyers make up the remaining 60 percent – less than before the crisis but still a healthy proportion.
This resurgence has been driven partly by renewed issuance. There are a lot more trading opportunities if outright buyers need to sell old bonds and buy new ones to rebalance. The elevated volatility environment is also helpful to arbitrage players as it promotes gamma trading, allowing more frequent and more profitable rebalancing.
In the boom year of 2020, convertibles returned almost 30 percent to their investors and $160bn was issued. 2021 was less dramatic but they returned almost 10 percent to their holders, comfortably ahead of many asset classes, while a little shy of $140bn has been sold.
However, there is now inflation to contend with. The October 2021 Consumer Price Index increase was the biggest for 30 years. Although 2022 will perhaps not see the same fevered issuance as 2020 and 2021, interest in the product from both borrowers and investors remains strong.
Generally, convertibles fare relatively well in an inflationary environment. They have lower durations than most other fixed-income assets so the credit component of the security is to some degree shielded from rising prices and rising rates. The average effective duration of the US convertible market is estimated to be 1.8, while for government bonds it is 7.2, and 8.3 for investment-grade bonds.
But the equity market exposure inherent in convertibles must give us pause. Over the past 18 months or so the convertible market has been dominated by new, high-growth borrowers with limited earnings history. For these sorts of companies, inflation is particularly worrisome.
Nonetheless, no one expects the convertible bond market to slide off a cliff edge in 2022. Strategists are still calling for $100bn of global issuance in 2022, and while this is less than the past two years it is not to be sneezed at – it is well above the 2012–2019 yearly average of around $80bn.
Convertibles are particularly difficult to value because they contain a number of advanced call and put features. To make informed decisions and take advantage of investment opportunities firms need access to powerful modeling, analytical, and pricing capabilities – as used by technology providers such as Quantifi.
For more information visit https://www.quantifisolutions.com/