The convertible bond market has grown about 36% in total from the end of 2019 through the end of March 2022, according to data from Bank of America Merrill Lynch’s global research team and Jefferies Group LLC.
Also, BofA and Jefferies data revealed that global issuance of convertible bonds averaged about $80.5 billion annually during the five-year period ended in 2019.
And with higher levels of volatility, the “option component within convertible bonds increases in value,” Mr. Miller noted. In addition, convertible bonds tend to have less interest rate risk than investment-grade or high-yield bonds because the “embedded option increases in value as interest rates rise,” Mr. Miller added.
“With inflation, for instance, there has been historically a strong correlation of rising interest rates during inflationary environments, as the Federal Reserve attempts to bring inflation back to its 2% target,” Mr. Miller said.
“Historically, going back to January 1977, when inflation averages above 2% for a month, the average 10-year U.S. Treasury yield has been 7.1%, and when inflation averages below 2% a month, the 10-year U.S. Treasury yield has been at 3.2%.”
During periods when inflation has pushed rates higher, Mr. Miller noted, traditional bonds have suffered losses, but convertibles haven’t been affected as harshly.
Convertible bonds have historically been “less volatile than stocks during periods of high inflation,” Mr. Miller said.
On a relative basis, Advent’s Mr. Maitland said, convertibles look attractive vs. core fixed income because of the option to convert to equity shares as well as its more attractive current yield. As of April 30, Mr. Maitland said, convertible bonds as represented by the ICE BofA All U.S. Convertibles index had a yield of 1.9%, vs. a 2.6% yield for the Bloomberg U.S. Aggregate Bond index. But the duration as of April 30 for convertibles was only 2.1 years, vs. 6.5 years for core fixed income, thereby limiting downside risk for convertible bonds, he said.
Also, relative to other fixed-income asset classes like high yield and bank loans, Mr. Maitland said, convertibles have experienced “meaningfully lower default rates historically, superior risk-adjusted returns over the past 10 years and material outperformance in periods of rising interest rates.”
Advent has $10 billion in assets under management.
Mr. Maitland said that in the 11 periods since 1992 when the 10-year Treasury yield climbed by at least 100 basis points, convertible bonds delivered an annualized total return of 20.14%, while 10-year Treasuries returned -7.75%; high-yield corporates gained 10.89%; bank loans rose 7.43%; and investment-grade corporates inched up 0.3%.
Depending on the underlying conversion price, convertible bonds can trade with “much less sensitivity” to inflation and interest rates compared to traditional, non-convertible bonds, said George J. Cipolloni III, Philadelphia-based portfolio manager at fixed-income specialist Penn Mutual Asset Management, which has $33.6 billion in AUM.
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