Convertible bonds: why now?

1. Why is the current environment favourable to convertible bonds?

Convertibles are always associated with convexity, and their ability to capture more of the upside than the downside of equities. Looking in the rearview mirror, this has never been so challenging but let’s look at why, and why we think this is going to change.

First, this assertion needs some precision. When talking of convexity, one needs to explain that it is the ability of convertibles to capture more of the upside than the downside of their underlying equities, not broad equity indices.

The opportunity offered by convertibles is very different to the one offered by broad global equities, since the median market cap of convertibles issuers is c.USD6bn, whereas it is c.USD130bn for the MSCI World Index¹. Therefore, when assessing the performance of convertibles, one needs to be mindful of the trends in the small-and-mid cap equity markets, which are a more appropriate comparison base. Since the end of 2020 and the asset class’s year of incredible performance, convertible bonds’ underlying equities have trailed the MSCI World Index by more than 63 percentage points². Convertibles are due for a catch-up, and our view is underpinned by three additional drivers:

1. Global small-cap equities trade at a discount to their 10-year median valuation.

2. Global small-caps also trade at a discount to large-cap equities, which is unusual, particularly outside periods of recession.

3. We believe small-caps enjoy faster growth expectations than their larger peers for 2025 and 2026.

We think that the next few months are going to be key as we should learn more about the path of US interest rates, the US labour market and Trump policies, which we expect to confirm a soft-landing scenario. We had false starts in July and August 2024 with small-caps ripping higher and outperforming large caps before fading. We believe the missing spark to unleash a rally should materialise shortly.

Second, we believe convertibles are now in a better place to offer asymmetry to the opportunities outlined previously. In 2022, they lacked downside protection due to rates, credit and valuation going against bondholders. In 2023, they captured c.75% of the c.17% rally in their underlying equities. In 2024, they displayed almost full upside capture (99.3%)³.

The main reason behind this improvement is the primary market. It has been roaring with USD80bn of issuance in 2023, twice as much as in 2022, and in line with the post-Global Financial Crisis-era average, and USD119bn in 2024⁴, which constitutes the busiest year since 2007, excluding Covid years. This has ensured a renewal of the opportunity pool by:

• bringing new names and new industries with a healthier mix of sectors and credit profiles.

• removing out-of-the-money, busted convertibles by issuing longer-dated, more balanced profiles with lower conversion prices.

• providing higher income and carry by replacing low-coupon structures (average coupon of global convertibles issued in 2021 was 1.4%) with higher ones (average coupon since 2023 is 2.9%)⁵.

All in all, in 2024 convertibles captured 19%⁶ more upside than downside of their underlying equities. We expect this trend to continue, if not improve further.

2. What are the potential benefits of adding convertibles into an asset allocation as a complement to equities?

The benefits are threefold. First, adding convertibles gives you access to a market that performed in line with global equities with half the volatility from the 20-year period from the inception of the MSCI World Index to the recent episode of disappointment⁷ that has now lasted for four years. The points we highlighted earlier make us believe this period of underperformance should end soon and reverse in favour of convertibles, with significant recovery and catch-up potential to get back to the historical trend.

Second, by buying convertibles you diversify away from large equity indices with an equally healthy geographical and sectorial mix but lower market capitalisation average.

Finally, unlike equities, we believe that you do not have to be so precise with the timing of your investment. The inherent convexity and lower volatility make this asset class, in our opinion, a suitable vehicle to improve the risk/reward profile of a portfolio.

Additionally, given the renewal of the investment universe we mentioned earlier, you now get income in the form of coupons, or in other words, we get paid even in a standstill scenario, unlike with equities.

3. What kind of diversification do convertibles bring compared to equities or corporate bonds?

If we go back and explore the roots of the product, convertibles are made to allow companies to raise funding at a lower cost than on the traditional bond market in exchange for having the risk of dilution in case of share-price appreciation. This is a solution that can be appealing to companies that are younger and or smaller than average and might not have access yet to the fixed income market. Alternatively, some companies might want to diversify their investor base, or some might use this as a differed capital raise. Nonetheless, it is no surprise that 63%⁸ of the companies in the convertibles universe only have convertible bonds as debt instruments on their balance sheet. The diversification convertibles can bring to a corporate bond portfolio is therefore clear.

The benefits are also clear when it comes to diversification from the usual equity indices. Unlike what most people believe, there is little difference in terms of sectorial or geographical repartition between the MSCI World and the convertible bonds universe. The average absolute divergence between the two universes at the sector and region level is 4%. Where the two universes are distinct is size: while the median/average market cap for the MSCI World is USD130bn/USD48bn, it is USD6bn/USD18bn for the convertible bonds underlying equities⁹.

Finally, certain features of convertible bonds make them uniquely positioned between shares and bonds. All convertible bonds, unlike other fixed income instruments, are protected against the delisting of the underlying shares. For example, in the case of a takeover by an early redemption option granted to the bondholder upon completion of a deal. Equally as interesting, the conversion price of 70% of convertible bonds is fully adjusted lower in case of the payment of any dividend (you are effectively treated as a shareholder, except it is via a non-cash adjustment) at a time where there are only 25% of convertibles left paying zero-coupon.

4. What tailwinds have you identified as underpinning your positive view on the asset class?

There are five tailwinds that we believe should support convertible bond performance, both in absolute and relative terms:

1. The primary market is back and should accelerate with equity markets close to alltime- highs and rates still high by recent history standards. We expect the renewal of the investment universe we have witnessed during the last 18 months to persist with investor-friendly terms.

2. With the average delta of the universe now at 51%¹⁰ from a low of 36%¹¹ exactly a year ago, we believe the asset class is in a sweet spot to achieve solid upside participation to any rally in the price of convertible bonds’ underlying equities.

3. 2024 was another year with more than a dozen companies having convertibles taken over, following on from 15 in 2022 and 13 in 2023. Over the last 10 years, 70% of targets had a market cap below USD5bn¹²; the current valuation disconnection should make them even more appealing.

4. Convertible bonds’ underlying equities have lagged the MSCI World by more than 63 percentage points since their peak at the end of 2020¹³. We expect this historically dramatic disconnection to normalise and deliver more favourable returns.

5. The current asymmetry of the asset class – its ability to capture more of the upside than downside of the underlying equities – should allow it to deliver performance consistent with its convexity promise (15% more upside than downside captured over the last 23 years, 17% in 2023 and 19% in 2024)¹⁴.

5. In which small & mid-cap segments do you find the most promising
opportunities?

We currently find IT, healthcare and materials as the sectors where you can selectively pick the best opportunities.

In IT, there is a lot of dispersion among the numerous sub-sectors: software, communication equipment and components, semiconductors etc. Besides AI and its value chain, we believe there are interesting plays in the software space with valuations failing to recover despite rates being lower and M&A activity solid (five deals in 2024).

We are also finding a lot of interesting companies in healthcare, where we are seeing profitable, multi-product names unfairly valued due to the indiscriminate sell flows smallcaps have suffered from. Healthcare is also a sector that sees a lot of activism, with as many as four companies going private in 2024.

Finally, we are strong believers in the precious metals super-cycle. Gold is at all-time highs and silver is at cycle-highs, despite both nominal and real rates being high by recent history standards. Yet most miners trade at a discount to their NAV, book/value or even historical valuations. This is even more interesting since balance sheets are strong unlike in the previous decade, and all companies with outstanding convertible bonds are multi-project, multi-jurisdiction.

Our positioning in terms of sector (and also in terms of delta, credit quality etc) is based on a top-down/bottom-up approach that aims to enhance convexity at all times, no matter the macro and market conditions.

What distinguishes the Mirabaud global convertible bond strategy?

Within our strategy, we look to always maximise convexity. Although the characteristics of convertible bonds should make them intrinsically asymmetric, there might be times or situations (in 2022, for example) where it is less or even not the case. Therefore, we take an active approach with an investment process that is designed to enhance the asset class’s properties.

The strategy is managed according to three core principles:

1. We offer a flexible, pure-play solution: we believe that to fully benefit from the interest offered by convertible bonds, we need to look at the market as a whole, capturing the diversity of stock-selection opportunities based on proprietary fundamental research rather than a broad index play.

2. We are active, high-conviction managers: we seek alpha generation by managing in a high-conviction, concentrated and agnostic way. Opportunities are identified worldwide, irrespective of their inclusion or weighting in the index or market capitalisation with flexible positioning according to macro views and regime change.

3. We believe in sustainability: the integration of ESG criteria into the investment process brings significant potential to enhance performance over time and mitigate potential risks.

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¹ As at 31 March 2025.
² Mirabaud Asset Management, FTSE, MSCI. From the 31 December 2020 to 31 March 2025 for the MSCI World USD Hedged Net Return and the FTSE Global Convertibles Parity USD Hedged.
³ Leversys, Mirabaud Asset Management, data to 31 December 2024.
⁴ Bank of America, data to 31 December 2024.
⁵ Bank of America, Mirabaud Asset Management 2021/2023.
⁶ Leversys, Mirabaud Asset Management 2024.
⁷ 31 January 2001 to 31 December 2020.
⁸ Mirabaud Asset Management, 30 June 2024.
⁹ MSCI, as at 31 March 2025.
¹⁰ FTSE Russell, as at 28 February 2025.
¹¹ FTSE Russell, as at 28 February 2025.
¹² Bank of America, Mirabaud Asset Management.
¹³ Mirabaud Asset Management.
¹⁴ Leversys, Mirabaud Asset Management, data to 31 December 2024.