Convertible Bonds

By Arnaud Brillois le

Important investment flows

As an asset class in its own right, the convertible bond market has gained an undeniable attraction over the past two years, materialised in the form of important investment flows. The proliferation of funds and the increase in allocation in this asset reflect this trend. We believe that multiple factors contribute to the strength of the asset class and its appreciation. Because two thirds of the convertible universe is either High Yield or unrated, the recent repositioning of High Yield CB’s towards Investment Grade within the asset class has led to renewed liquidity and investment opportunities.

In times of volatile markets, investors have the tendency to look for asymmetric investment opportunities, that is to say they want to participate in the growing performance of equity markets in bullish periods and conversely be less exposed in bearish phases, what is also called convexity. We believe that convertible bonds offer therefore an interesting solution for the risk/return parameter. Furthermore, the asset class has not experienced a dramatic sell-off throughout the period of strong market volatility in recent days and repositioning after correction was fast, demonstrating investor confidence in the asset.

A return of convexity in Europe

Before the recent market correction, the main source of convexity stood almost exclusively in US convertible bonds. Throughout the first half of 2015, we partially took our profits from European bonds in our international fund, all the while remaining overweight in this area and focusing most of our investments in convex American convertible bonds. Following the recent market corrections, asymmetric investment opportunities are now also present in Europe. Thus we have found again the attraction towards European convertible bonds which became “mixed” and whose underlying shares have solid fundamentals.

In the Asian markets, which have been turbulent lately we remained very underweight over the past two years. The few Chinese bonds selected in the global fund have either a particularly high bond floor or are currently converging towards par in light of their reimbursement. We stay away from the Chinese property sector highly represented in the universe. Moreover, the direct impact of the collapse of Chinese stock exchanges is very low.

A beneficial appreciation of the dollar

The US dollar has recently experienced a sharp correction. However, the forecasted rate hike in the United States should bring medium-term appreciation of the US currency. Furthermore, historically, convertible bonds have shown good resistance to interest rate hikes due to their low sensitivity. The global exposure of our fund towards the US dollar is now above 60%.

The current conditions – strong corrections across all markets – represent an excellent entry point or reinforcement point in convertible bonds. We remain very positive in the asset class that we believe will benefit from the stock market rebound. Our tactical positions, ie overweight in equity markets, very low sensitivity beneath 0,5 and our choice of securities in convex US convertibles with bond floors represents the best positioning, in our opinion, to take advantage of the markets according to our macroeconomic forecasts.
Security selection, which is essential in our conviction management, requires a thorough analysis of underlying characteristics and issuance prospectus. Major exposures are managed in line with the macroeconomic scenario.
Arnaud Brillois is the co-head of the Systematic Flexible Management, Convertible Bonds, Alternative Investments and Structured Products department at Lazard Frères Gestion since 2008. With over 15 years experience in the management of convertible bonds, he manages over 500 million euros through a range of three funds positioned in global convertible bonds (Objectif Convertible), European and Euro area.

 

This document is not pre-contractual or contractual in nature. It is provided for information purposes. The analyses and descriptions contained in this document shall not be interpreted as being advice or recommendations on the part of Lazard Frères Gestion SAS. This document does not constitute an offer or invitation to purchase or sell, nor an encouragement to invest. This document is the intellectual property of Lazard Frères Gestion SAS.

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