Views and Analysis

Why Now is a Great Time to Invest in Convertible Bonds

Despite the recent market sell-off and turmoil, we think that the recent correction will not continue and we believe that the underlying equity backdrop remains constructive.
Dips provide astute investors with an opportunity to add to their allocation for the following 8 reasons:

1- The US activity is not about to step lower
The 20% fall in oil prices over the past 3 months and the 50bp YTD drop in US mortgage rates both have a significant positive impact on spending.

2- A strong dollar is supportive to growth
It should help global exports and consumer purchasing power.

3- European margins have scope to expand
The currency is weakening and monetary policy is becoming increasingly stimulative.

4- The US earnings season has started well
The first few current Q3 2014 releases (Alcoa, Citigroup, Pepsico and Infosys) all were actually decent.

5- The cyclical sectors valuations are very attractive
They represent 2/3rds of the global convertible universe and trade at a 12M forward PE discount of 20% against the defensives, compared to an average discount of 3% in the last 10 years (Source Morgan Stanley).

6- The underlying credit fundamentals are not worrying
The default rates remain very low, leverage is rising but remains low and profit margins are still very high.

7- The convertible asset class is now discounted by 1%
From a valuation standpoint, we believe there is now a market entry level on the asset class, as there is now a majority of fair valued and discounted convertibles in the Investment Grade space and balanced names.

8- Convertible bonds are back in positive yield to maturity
This cheapening has contributed to increase the yield to maturity (MCBE : +0.4%, MCBG +0.8%), which increases even more the average convexity expected over 1 year.