In 2021, convertible bonds had to pay tribute to the strong performance of the previous year. While many stock markets performed in double digits, the Refinitiv Global Focus Convertibles Index (EUR hedged) fell by around two percent over the course of the year. So while stocks worked, converters stuttered. Why?
The Convex Experts founder and managing director trio (from left to right): Mag. Paul Hoffmann, Dipl. Bw. Nils Lesser and MMag. Bernhard Birawe© CONVEX Experts GmbHIf you look at the convertible bond instrument and the convertible bond market separately from the stock market, convertible bonds continued to follow their theoretical models in 2021.Reasons for the discrepancy in the performance of convertible bonds and equities
Bernhard Birawe, one of the three founders and managing directors of the Vienna-based convertible bond boutique Convex Experts, knows that the reason for the meager yield of convertibles in relation to the stock market lay in the universe: “More than 50 percent of the underlyings in the global convertible bond index had a negative performance. 40 percent of the underlying stocks were down more than 10 percent and 18 percent of the stocks were more than 20 percent below their year-opening levels.”Converters of penalized growth convertible bond indices fell
Among them were many well-known names such as those from Twitter with -20 percent, Wix with -37 percent or Beyond Meat with -48 percent. The underlyings of other prominent convertible bond issuers have corrected so sharply (eg Peloton with -76 percent) that their convertible bonds have fallen out of the index due to the high premium.Under these circumstances, convertibles delivered what was possible
Convertible bonds were mostly able to cushion the sometimes sharp corrections in the underlying shares. In this respect, they delivered what is expected of them in such a situation.Equity Return Dispersion: Big names with no outstanding convertibles rose
“However, since on the one hand an unusually large proportion of the convertible bond universe corrected and on the other hand the big heavyweights of the equity indices (Microsoft, Alphabet, Apple, etc.) – which were often the main drivers for the good performance of the largest equity indices – were not represented in the convertible bond market, the Performance 2021 differs greatly from that of the stock market,” says Nils Lesser, also founder and managing director of Convex Experts. “Four times a century”
Would probably be the answer to the question: “Does this happen often?” You have to look back in time more than 25 years to find such a discrepancy. As the chart below shows, 1994 was the last year in which equities had a positive annual performance and convertible bonds had a negative annual performance at the same time.Rare discrepancy in earnings direction for stocks and convertersSource: Bloomberg, Convertible bonds globally hedged in EUR (green) compared to equities globally hedged in EUR incl. dividends (blue)The decisive perspective: do not look at one year in isolation!
The composition of the universe of the global convertible bond market is noticeably different from that of the global equity market. “In some years, these differences are also clearly reflected in the performance. 2021 was one of these years, as was 2020,” says Paul Hoffmann, third founder and managing director of Convex Experts. “The global equity market closed 2020 up almost 12 percent in EUR-hedged terms. A typical performance expectation would have been in the range of 5 to 8 percent for convertible bonds. In fact, the price gain was more than 20 percent. Despite the much lower volatility, the global Convertible bond market around 185 percent of the stock market performance. So if you look at the period of two years, the picture is quite consistent and the convertible bond asset class was able to fully meet expectations in the long-term perspective – despite the exceptional situation Corona.”Converters versus Corporates IG, High Yields, EMD and Equities in a 2-year comparisonSource: Bloomberg, 01/01/2020 – 12/31/2021, Convertible bonds global in EUR-hedged (turquoise) and the ART Top 50 Smart ESG Convertibles UI (white) compared to: Equities global in EUR-hedged incl. dividends (green), Corporate bonds in EUR total return (orange), high-yield bonds in total return (yellow), emerging market bonds in EURhedged (red),Outlook from Convex Experts
“After the exceptional year 1994, 1995 was followed by a very good year for the convertible bond asset class. Of course, no statement for 2022 can be derived from this alone. What is certain, however, is that a significant part of the investment universe has already experienced a significant correction,” says birawe This has now lasted ten months and affects a little more than 50 percent of all titles in the universe. It is also clear that the valuation levels of the convertible bonds in all four relevant regions are below the long-term averages. As a result, the profile of the convertible bond market in early 2022 is much more balanced than it was a year ago. Interesting opportunities are constantly arising from this. In addition, convertible bonds are hardly affected by rising interest rates because they have a relatively short duration. For most funds, this is around two years. Historically, convertible bonds – like equities – would have performed well during periods of higher inflation.It depends on the expertise
“We were also able to show this in 2021,” says Nils Lesser, not without pride. “The ART Top 50 Smart ESG Convertibles UI had a positive performance of about 0.4 percent in 2021, with more than one percent being generated from M&A activity and takeover clauses. The fund achieved this in contrast to the corresponding Morningstar peer group or the comparable global convertible bond Index 2021 a slightly positive result.” Since it was launched on May 25, 2018, the fund has achieved a performance of 5.76 percent per year and is therefore within the longer-term performance expectations. The focus on the key value drivers of the asset class – highly convex profiles, incorrect valuations and takeover protection clauses will also bring advantages in the future. The ART Top 50 Convertibles UI and the ART Top 50 Smart ESG Convertibles UI will pay out around 2.25 percent in February in accordance with the long-term distribution policy designed for consistency. With the newly launched Convex Conservative Sustainable Convertibles, Convex Experts has also been offering a conservative variant since November 2021 to invest in the asset class. The fund is also an alternative for the pension sector, in a scenario of rising interest rates it can provide additional value drivers here. (kb)
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