Managers cap convertibles,but opportunities remain


Convertible bond fund managers are united in seeing market opportunities, though divided on when they have enough assets to pursue them.

Manager resources and narrow mandates – around emerging markets or ratings criteria, for example – also play a part in decisions, says Oliver Dobbs, chief investment officer for portfolio management at CQS.

The move to cap at F&C came on the back of inflows and as new issuance increasingly moved to sub-investment grade and unrated companies, says Anja Eijking, head of convertibles at F&C.

“Within our investment style of focusing on quality, issuers and some 65% invested in implied investment grade convertibles, this meant the investable universe is shrinking.”

Taking excess inflows can force managers to hold near benchmark weights and only liquid securities – “not always the best in terms of downside risk control”, according to Dorian Carrell, Schroders’ global convertibles analyst.

Schroders will close its $600m Global Fund at about $2.5bn, and conduct detailed capacity analysis when its $180m Asian fund hits $1bn.

Carrell says: “We think the market is $700bn globally or more, but you have to look at the amount of outstanding [issues] and what percentage is tradeable. You also must have regard to who holds the issues because you can have a large issue, but held only by one or two players so in effect it is not liquid.” Whether or not their funds are capped, managers concur convertibles’ broad post-crisis recovery rally is over – they jumped 24% in 2009, then over 9% last year – and now trade around fair value.

Dobbs says: “There is big dispersion [in valuations], and therefore a lot of opportunities. You can find cheap issues to buy, or avoid expensive ones if you are a long-only fund manager.

“You need to look at as many different types of convertible issues as possible. If you have fairly limited goals, it could limit the size you can be in that space.”

Finding ratchet clauses in bond documents has been a boon for CQS, in cases such as Louis Vuitton’s planned €3.7bn takeover of Bulgari where the luxury designer label must pay holders of Bulgari convertibles “significantly” as part of its deal.

Dobbs adds that research is also needed, for example, to identify where European government entities may support issuers, “or where an issuer is just a standalone entity, which could be let adrift”.

Many managers also research new geographies. Schroders is examining South America, and already invests in Asia, the fastest growing market for convertibles last year.

Carrell, who will soon relocate there, says: “From a long-term perspective, we think Asia represents a fantastic opportunity and the convertible market there is underdeveloped.

“Companies that issue them are typically small- and mid-sized and trying to finance their growth, which typifies companies in the fast growing economies. We expect that will continue because of rising rates and rising equity markets – ideal conditions for issuing convertibles.”

Managers note the composition of investors in the market changed dramatically post-crisis, reverting to its pre-crunch status quo when various institutional investors held about 70%. It is healthier than from the mid-2000s, when a similar dominance was enjoyed by leveraged players, chiefly hedge funds and bank trading desks.

Carrell says one problem of having so many hedge funds present before was their leverage – some estimates suggest 3.5 to four times assets – which heightened volatility.

Convertible arbitrageurs now are about 2.5 times leveraged, he says.

“Now we also have credit buyers, long-only convertible funds, credit arbitrageurs and some equity income players in the market, too,” he adds.

“The inevitable next step is more defensive equity income managers looking for a coupon clip, and we think the coupon clip [from convertible bonds] gives equity players the equivalent of a dividend yield, but not a dividend that can be cancelled.”

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