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Convertible Bonds

Downside protection is greater, but selectivity will be everything

Convexity made a comeback over the second half of 2022, making selectivity crucial for new-year markets.

Under typical conditions, the convertible market is far more responsive to the equity market than it is to the bond market. However, as shown in the chart, 82% of a convertible bond’s (CB) value in the US is currently derived from its bond value according to Bank of America (BofA) research, which analysed the theoretical value attribution over the previous two decades.

Given that the market is currently more focused on bonds, it is not surprising that credit and default risks are on the minds of many CB investors – yet credit conditions within the convertibles universe seem generally favourable.

Bond proportion of convertible bond value

Source: Bank of America, Mirabaud Asset Management as at 31 December 2022. CB refers to convertible bonds.

According to BofA, 47% of "busted" global CB names – which trade below a price of 80% – only have CBs listed as balance-sheet debt. Additionally, the average coupon of all "busted" CBs globally is still less than 1%. Since it is simpler to refinance a convertible when it is the sole debt, this indicates that among global "busted" CB brands, total debt levels, leverage and interest expenses remain low.

Nevertheless, because credit ratios are anticipated to significantly decline in the upcoming months, fundamental analysis will continue to be key.

We are confident that 2023 will present real investment opportunities, but we also believe that the credit market's lowest-rated parts will remain vulnerable.

Convexity made a comeback over the second half of 2022 and we expect it to stay, so selectivity will be crucial. We believe that investors undervalue credit analysis across the capital structure, while being encouraged by the recent rise of high yield investors who started competing to purchase CBs with attractive yields.

Uncertainty brings volatility, but also alpha-generation opportunities. More than ever, we regard an active management approach as a key advantage.

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