Let’s start by understanding why convertible bonds are issued. In a word, flexibility! Sitting between debt and equity, convertibles have proven highly useful for issuers in unusual conditions, such as ones created by the coronavirus pandemic.
Convertible bonds suit issuers in need of equity-like financing. Unlike an equity rights issue, which sells new shares at a discount, convertible bonds are launched at a premium to the prevailing share price. In early 2020, we saw issuers with businesses affected by lockdown restrictions—such as airlines, cruise lines, and retailers—use convertibles to shore up their balance sheets. And because holders may choose to convert their bonds into equity, the issuer might not need to repay at maturity with cash.
Convertible bonds can also help issuers that are looking to raise capital for growth. We saw many convertible bonds launched in 2020 by companies to finance expansion; for example, technology companies who benefited from remote working and learning conditions.
Finally, convertibles work well for issuers looking to raise money quickly. Many convertible bonds are unrated, and the sensitivity of the share price to the conversion option means that deals are usually announced and closed on the same day, compared with a much longer process of a roadshow and bond rating for straight debt.
Going back in time, we can see that this flexibility has been very useful to corporates. Convertible bonds have a long history, with the first issuance coming from a US railroad in the late 1800s. In today’s global convertible bond market, the issuer base is broad, with most corporate sectors and regions having representation. Growth-focused sectors tend to have higher representation than they would in the corporate bond markets.
How big is the market?
Record issuance in 2020 helped to push outstanding convertibles over the $600bn mark, according to Refinitiv. This is the largest that the market has been since the all-time high of $727bn reached in May 2008. As of early March 2021, the convertible market is more than $660bn in size[1].
Yet this recent pickup in activity follows a decade that was quiet for equity-linked issuance, with the market as small as $400bn at the end of 2016.
Two developments following the 2008-2009 financial crisis period explain much of the shrinkage in convertible issuance. First, the winddown of leverage extended to hedge funds led to losses and a sharp reduction in capital employed to convertible arbitrage strategies, which had represented the bulk of the investment in the asset class. Second, the easy money policies adopted by central banks both lowered headline interest rates and suppressed volatility, both of which caused a migration of issuance from convertibles to straight debt markets.
However, these conditions have now changed. Long-only, directional investors are now the main investor base for convertibles and realised volatility has been on the rise since the end of the last decade. Combined with the need for flexible financing during the pandemic, convertible issuance has been resurgent, and we expect that trend to continue.
Why invest in convertibles?
Second, convertibles can also provide a useful alternative for fixed income allocators. They are still bonds but can deliver equity-like returns with bond-like volatility. This can help returns under scenarios that might be positive for equities but bad for bonds; for example, if growth picks up and inflation expectations and central bank rate hike probabilities increase. Also, many convertible issuers do not have any other straight debt, so an allocation to convertibles brings credit diversification.
Third, within a multi-asset portfolio, convertibles bring convexity that cannot be replicated from combinations of stocks or bonds alone, which helps the allocator to push out the portfolio’s efficient frontier. That is, the convexity from convertibles helps to create a potential portfolio with better expected returns without having to accept higher risk, and therefore a higher Sharpe ratio.
[1] https://www.refinitiv.com/perspectives/market-insights/global-capital-markets-smash-records/
The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.
RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.
This document is directed only at professional, institutional, wholesale or qualified investors. The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.
This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, accounting or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, security, commodity, financial instrument or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party.
RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.
Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of investments can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated. Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer.
The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates.
Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient.
AIFMD and Distribution in the European Economic Area (“EEA”)
The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.
In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor).
Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in Switzerland
The representative and paying agent of the RWC-managed funds in Switzerland (the “Representative in Switzerland”) is Société Générale, Paris, Zurich Branch, Talacker 50,
P.O. Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland.
