Despite a slower start to 2021, convertibles provide some characteristics that should position the asset class well if volatility in markets picks up as a result of rising inflation and rates.
Against equities, such as the Euro Stoxx 600, European convertibles have lagged this year. However, much of this has been due to the sector breakdown of convertibles. For instance, there are no resources or banking names in the European convertibles universe – emblematic industries that have benefitted the most from the rotation into more value parts of the market.
Positioning
The portfolio remains 40% positioned in value names, with the balance in growth.
Areas that have done well this year include semiconductor companies, securities in cyclical sectors and industrials. We have continued to benefit from our economic reopening names in the retail, automotive and travel & leisure industries. Surprisingly, our exposure to green energy companies has been a headwind, because they are sensitive to rising rates. However, they index revenues and as inflationary pressures remain under control for renewable developers, we expect some performance catch-up. Green energy issuers also remain in strong demand from areas such as private equity and the traditional fossil fuel companies
Other detractors included payments-services companies, which have not recovered alongside other reopening names. However, we see this as just a delay and expect these companies to perform well in the months ahead as confidence builds following the success of vaccination programmes.
Re-opening and a focus on equity exposure are key themes
With a delta of 52[1], we continue to maintain our bullish view on the market. We are also maintaining a strong convexity, which should be helpful for timing the market if volatility returns in the months ahead.
We continue to invest in the cyclical/reopening trend, which led to strong outperformance between January and April. At this time, we were also underweight technology stocks. With government bond yields in the US moving from 0.8% to 1.8%, interest rates were up to 1.4%[2] - which meant many technology growth stocks priced for perfection, where valuation is heavily weighted towards terminal value did suffer a lot from highest discount rates. However, we see a lot of recovery potential in specific technology names and have been selectively adding positions to the portfolio.
We remain focused on the reopening names, which now consist of 40% of the portfolio versus a 25% weighting in the benchmark. This includes issuers in sectors such as travel, leisure and real estate. In fact, the management teams we have been speaking to recently across the Fund’s reopening names, all indicate that demand is continuing to rise. This has led us to take positions in the travel industry – perhaps the worst affected over the past year – with new investments in duty-free retailers, including WH Smith. We have pared back our aerospace holdings following a run of very strong performance.
Primary market opportunities remain buoyant
We continue to see a number of new opportunities in the primary market, where activity has remained strong since the beginning of the year - with 35 new issues. These are diversified across sectors, allowing us to build on our reopening theme, as well as picking up technology names coming to the market to boost growth. Out of these new issues, 13 have been in the reopening space and nine have been in technology-related issues – areas that we are focused on right now. The other advantage to the ongoing growth in the primary market is that it adds to liquidity. Many of these new issues have been in mid-cap names, with a good coupon, some over 2%, which provides some carry.
Other supporting factors include Merger & Acquisition activity, which remains buoyant, alongside still attractive valuation levels for European convertibles, and an implied volatility that is lower than the volatility of the listed option.
Our outlook
Around 65% of the Fund’s portfolio is driven by the direction of the equity market. We remain bullish in our outlook for the European economy and any volatility caused by expected inflation will provide buying opportunities. Earnings should also continue to be strong, which will drive equities – and convertibles – in the months ahead.
| 2021 | 2020 | 2019 | 2018 | 2017 | 2016 |
Fund I Cap EUR | 1.05% | 7.12 % | 9.37 % | -8.57 % | 2.02 % | -0.95 % |
Benchmark | 0.36 % | 8.11 % | 6.04 % | -5.48 % | -0.03 % | -1.12 % |
Benchmark: Exane Europe/Refinitiv EUR Focus CB EUR. 2021 figures to 31 May 2021. Past performance is not indicative or a guarantee of future returns.
[1] 18 June 2021
[2] Bloomberg, June 2021
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