Convertibles are fair-weather vehicles, and their financial namesakes certainly enjoyed the sunshine of 2016.
Contrasting managers’ performance over the past year with their three-year record makes the point particularly clear: four of the top five strategies over the past three years generated higher total returns in the past year alone than they did for the full period – the three-year numbers are not annualized.
Convertibles rallied so strongly in 2016 thanks to their equity-like characteristics, and their future fortunes will depend heavily on the stock market too. Yet David King, Citywire AA-rated co-manager of the Columbia Convertible Securities fund, highlighted other factors that can benefit the asset class specifically.
Certain sectors, for example, may have further to run. As well as biotech and software, King pointed to energy.
‘Companies in cyclical industries that are coming out of a downturn, such as energy, often issue convertible securities to raise capital to fund new projects, because it can be quicker and cheaper than going through the bond market,’ he explained.
‘Following the partial recovery in oil prices and the November Opec agreement, more energy-related companies are now issuing convertible securities.’
Heart of the issuance
Greater issuance is a theme identified by several other investors. ‘Compared with a few years ago, issuers have been coming from an increasingly diverse mix of sectors, countries, industries and market-capitalization sizes, which has widened our potential investment universe,’ commented Alan Muschott, + rated co-manager of the Franklin Convertible Securities fund.
‘Because convertible bonds typically carry a lower coupon rate than straight debt due to their conversion option, they can be a more attractive option to companies in higher-rate environments.’
Edward Silverstein, manager of the MainStay Convertible fund, added that the ‘preponderance’ of new issuance has come from lower-rated companies because investment-grade corporations can still sell traditional debt very cheaply.
‘In addition, following the stock market decline of 2008, companies were reluctant to issue equity-linked securities as they believed that doing so would dilute existing equity holders at prices they believed undervalued their companies,’ continued Silverstein.
‘However, with stocks at near-record levels, companies are no longer reluctant to issue a security linked to their equity.’
Top convertibles managers by three-year total returns
|Manager||Fund||Total Return (%)||Market Share (%)|
|3 Year||1 Year|
|Miller Convertible Bond|
Miller Convertible Plus
James K. Kaesberg
|Victory Incore Investment Grade Convertible||18.2||12.5||0.2|
|Franklin Convertible Securities||17.7||19||5.5|
|Edward Silverstein||MainStay Convertible||17.4||20.4||6.9|
|Columbia Convertible Securities||16.2||24.3||2.6|
Converti-bulls and bears
Elevated stock markets nevertheless pose a risk to convertibles. The main convertible index had a delta, or sensitivity to equities, of around 0.6 in mid-February, implying the securities were likely to capture approximately 60% of any upside in shares or 40% of any downside.
Among the top five managers over the past three years, Wellesley Asset Management’s + rated team of Greg Miller and Michael Miller have positioned themselves defensively, citing concerns about the length of the current bull market and likelihood of political volatility ahead.
They observed that ‘the standard deviation of our returns is typically half that of equities,’ although investors should be aware that of their funds in this space Miller Convertible Plus employs leverage.
Amy Bush and James Kaesberg, managers of the Victory Incore Investment Grade Convertible fund, instead diversify their portfolio across three sleeves: equity-sensitive convertibles, ‘total return, middle-of-the-road convertibles’ and more defensive convertibles.
Muschott also described his approach as ‘balanced,’ with convertibles that ‘tread the middle ground between equity- and bond-like characteristics.’