After increasing by +6% in 2019 and more than +8% in 2020, European convertible bonds remained in positive territory in 2021, rising 0.46%.[1] The asset class has demonstrated the power of convexity. For example, in the downward phase of markets in 2020 as a result of the pandemic, European convertibles carried less downside risk and then participated in the rise of the equity markets over the last twelve months. However, this demonstration of convexity is not their only advantage. As the asset class has a lower sensitivity to movements in interest rate increases, as a result of the option embedded in a convertible, it means the value of the option appreciates when rates rise, which compensates for the negative impact on the bond portion of the convertible.
Another supporting factor is that convertibles have contractual clauses that can prove to be very lucrative in scenarios of change of control (ratchet clauses), which bodes well for 2021 as we anticipate a more dynamic market in merger and acquisition activity. Furthermore, market liquidity has remained remarkable in the crisis. During the month of March 2020, the volumes handled increased compared to the previous year. As a result, the primary market has experienced an explosion of new issues.
New issuance driving the market
We believe that new issues are an important driver of the European convertible bond market. As new entrants come in, it gives us the opportunity to diversify risk and access a broader range of issuers. The convertibles asset class has been an efficient refinancing tool for a number of issuers impacted by the Covid-19 crisis, whilst continuing to finance the development of a pool of companies with high growth potential or groups supporting the energy transition. As a result, the volume of new issues in 2020 was record-breaking, totaling 26 billion euros, compared to an average volume of 12 billion euros per year since 2016. So far this year, the rate of issuance remains extremely dynamic and we’ve seen 12 billion euros of new convertibles issued since early 2021[2].
Looking ahead, the growth in the financing needs of companies should maintain the momentum of the primary market. Traditionally, issuers in sectors such as utilities, telecoms and even real estate have dominated the European convertibles market. However, the recent growth in the primary market has been led by issuers requiring liquidity that they could not obtain on the traditional bond market or equity market. This has led to an expanded diversification of the convertibles market in other industry sectors, such as airlines and companies where income is closely linked to the resumption of air traffic (aeronautics, specialised retail, travel agencies, etc.). At the same time, the field has opened up more and more to companies in the new economy, which have been direct beneficiaries of the crisis favouring issuers in areas such as meal delivery or online commerce.
Europe is well positioned
Today, we believe the European convertibles universe remains very well positioned, particularly in relative terms compared to other areas of the convertibles market:
- An optimum convexity zone: the European convertibles universe offers a wide choice of balanced profiles, with an average delta (i.e. sensitivity to equities) around 50, along with strong convexity. In contrast, the delta in the US is around 75 or in Japan where it remains defensive at around 37.
- A less marked "growth" bias: while the US convertibles universe is largely concentrated on issuers in the technology sector, Europe provides a strong balance between issuers in so-called "recovery / reopening" sectors and those that are positioned to capture tailwinds from themes such as digitisation, or even the energy transition. In addition, beyond the “green” issues, which have multiplied, European issuers are more advanced in taking ESG considerations into account compared to the US, which is now an essential point for investors.
- Valuations are attractive: The European universe offers a discount of 1% compared to its theoretical value, while the US universe of convertibles is "fair value"[3].
Adopting ESG integration
We believe that ESG factors have an important role to play in convertibles. It enables us to better assess the short and medium term risks attributable to issuers from ESG impacts. When we select issuers, we look at both financial and extra-financial criteria, with a fully integrated approach to ESG as part of the investment process.
The best of both worlds
For investors seeking exposure to European market opportunities, either through bonds or equities, convertibles provide the relative stability of fixed income with the ability to capture equity-market upside. A unique asset class, the nature of convertibles cannot be replicated by combining separate portfolios of fixed income and equity securities because of the embedded option in a convertible. We believe that this makes convertibles an appealing asset class to help diversify risk.
[1] Source: Refinitiv European Focus Index (Hedged) EUR
[2] Source: Barclays CB research
[3] Source. Nomura CB Research, as at 30.04.2021
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