We believe that convertibles remain strong on a risk-adjusted basis and have the ability to generate strong returns in early recovery periods.
There are five supporting factors for the asset class in 2021:
Convertibles are a strong complement to equities
Convertibles can be used to enhance a traditional equity allocation as a result of convexity. Convertibles usually capture 40-70% upside of equities and 20-50% on the downside, which provides a good source of diversification, especially when the market environment is more volatile*.
Merger and acquisition activity will be supportive
We believe that risk asset valuations are high, however, the exuberance is rationale given the economic normalisation following the steep recession that global economies experienced in 2020. In 2021, they are on a positive trajectory, which will provide a favourable environment for risk assets. Furthermore, central banks are unlikely to deviate from their accommodative stance. Against this backdrop, we expect an increase in merger and acquisition activity, which bodes well for the asset class.
Inflation is set to increase, emphasising the structural attractiveness of convertibles
Inflation is expected to increase, which will result in a steepening of yield curve. However, this reflects the growth recovery and as a result, we don’t believe it will be the time to move risk-off. In this context, convertibles provide duration protection in rising rate environments because they have negative correlation to government bonds. However, they are also positioned to participate in equity market upside, because they have positive correlation to equities and corporate bonds. It’s for this reason that we believe equities will be the main driver of convertible returns this year.
Convertible valuations remain strong
Valuations continue to remain strong, supported by higher expected market volatility, which we believe will remain until middle of 2021, driven by rising covid cases during the pandemic. Convertibles still remain 0.9% cheaper relative to fair value – this is still below peak levels a year ago when convertibles were trading at a premium of 0.4% relative to fair value*.
New issuance continues to provide a good source of opportunity
A significant slew of new issuance has been highly supportive for convertibles – 2020 saw $138bn of new issuance across 269 deals, which is an all-time high. New issuance creates the opportunity for us to access new names across a broad range of industry sectors to replace existing names that have become too ‘bond-like’ or too ‘equity-like. ’ This flexibility is key given our focus on maintaining a balanced profile and 62% of the Fund reflects new issues that we participated in during in 2020 and 2021 to date. The outlook remains supportive because we expect that companies will accelerate their capital raising efforts this year to position for the ongoing pandemic and to plan for future growth**.
The Fund is positioned in the most convex segment of the valuation curve, holding 80% of balanced profiles, 17% of bond profiles and 3% in equity profiles**.
In combination with these supporting factors mentioned above, we are focused on six key angles:
A deep focus on sustainability: Over the last year, the convertibles investment team has engaged with more than 30 companies on ESG topics. Two thirds of the Fund’s securities are ranked among the first half of our universe for ESG factors based on our proprietary methodology.
Lower equity sensitivity: Our strategy has become less equity-like as we have reduced equity sensitivity to 50% in contrast to 58% of the benchmark (Refinitiv Global Focus CB Hedged US)***. Given the scope in the coming months for volatility, as potential issues with vaccine rollouts and Covid-19 infection rates, a pullback in equity markets at some point in the coming months is likely, especially given how stretched valuations in some sectors currently are. We are, however, relaxed about the possibility, as it will provide a number of buying opportunities. As vaccine programmes roll out, this will unlock areas such as the service economy, which will be supported by higher savings rates that have risen during the pandemic. As a result, any market correction will provide a good re-entry point to raise equity sensitivity.
Fixed income composition: We expect shorter duration and higher yielding assets to outperform quality and long duration in 2021. Alongside this, default rates remain low for the convertible asset class. For example, US convertibles experienced a 2.2% default rate in 2020 – this is three times less than the 6.5% default rate in the high yield market*. The strategy has a current duration of 3.8 years, with an equivalent credit rating to S&P BB+, reflecting a portfolio of 42% investment grade names and 48% in high yield names**.
We have expended our regional diversity: The unprecedented amounts of central bank stimulus will lead to a weaker US dollar, which historically has provided powerful tailwinds for non-US companies. As a result, we have increased allocations to Asia, including Japan, with an 8% and 7% overweight position to Japan and Asia respectively. In contrast, the Fund is 6% underweight in the US and has a 9% underweight position to Europe.
Sector diversification: A significant sector imbalance remains in the Fund’s benchmark, with Technology, Healthcare and Consumer Discretionary representing around 56% of total bench-assets. This means selectivity remains key. The impact of virus mutations has delayed the pro-cyclical trades that was under way. Our preference shifts back towards the Covid-19 safe havens until the vaccine deployment starts to have a material effect.
Small and mid-cap focus: The Fund is 62% weighted towards small and mid-cap companies with a market cap of below US$ 5bn, against a 6% position in the benchmark across the same asset class. This reflects the high active share ratio and the Fund’s high off-benchmark exposure of 67%***
Because we expect both further challenges and opportunities in the months ahead, convertibles should offer an ideal investment for investors looking for a risk-return profile between equities and bonds.
Past performance is not indicative or a guarantee of future returns.
*Source: Mirabaud Asset Management
**Source: Mirabaud Asset Management, 31 December 2020.
***31 December 2020. The benchmark for the Sustainable Convertibles Global Strategy is Refinitiv Global Focus CB Hedged US. The benchmark is shown for comparison purposes only.
Mirabaud- Sustainable Convertibles Global Fund I Cap USD
| 2020 | 2019 | 2018 | 2017 | 2016 |
Fund | 33.58% | 16.70% | -6.30% | 6.17% | 1.92% |
Benchmark | 22.84% | 13.10% | -3.01% | 6.00% | 1.52% |
Benchmark: Rifinitiv Global Focus CB hedged USD.
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