Irina Ons Vilaboa, CFA
- Resilient through economic cycles: Convertibles shine in growth and hold their own in both inflation regimes while cushioning losses during downturns, materially reducing volatility vs comparable equities.
- Equity + Fixed Income hybrid advantage: The dual nature of convertibles helps investors capture gains when markets rise and limit drawdowns during declines, offering a “best of both worlds” structure.
- Support for innovation and stability: Convertibles are a key funding tool for forward-looking sectors like AI and wider Tech - benefiting from innovation while offering risk mitigation.
You are not invested in convertible bonds? You don’t say?!? Really? Rain or shine, figuratively speaking, of course, convertibles come through time and again. You ignore convertibles as an asset class at your own peril, especially if stormy markets lie ahead. This asset class offers a sturdy floor (literally!) for support when things get rough, as well as a tailwind when the weather improves. Impressively, convertibles have been around since 1880 (not a typo!) and all sorts of cool kids dabble in the asset class through issuance, repeatedly.
Nobody ever really knows what is yet to come, and even less so now: higher inflation, lower growth, more geopolitical turmoil, a Molotov cocktail of all of the above and then some! Take your pick. What is known is that investing and staying in convertibles can make you a winner either way. You say, ‘bold assertion’, I say ‘factual’. You say, ‘prove it’, I say ‘easy’!
When convertibles play defense while the markets are heading to the proverbial south, the fixed income component is what helps mitigate the drawdowns. As a cherry on the cake, the default rates in convertibles are predominantly lower than in the neighbouring high-yield market, especially at the time when it counts, as evidenced during 2008/2009 and 2020 by the US convertibles, the largest market of issuance. For example, for 2020 it was 2.2 and 6.5 in CB’s favour, according to Barclays Research[1], but who is bragging? When markets go back to the greener pastures up north, the equity component is there to wipe away your tears at a faster rate than you would otherwise be able to achieve. How is this not a win-win?
Convertible bonds ‘economic regime affinity'*
Need even more reasons? See for yourselves: in the 2 charts below, convertibles held their own during both rising and falling inflation economic regimes and absolutely shone when the growth regime was in force. They carried you through like a trusted steed across many decades and choppy waters, helping you stay the course.
PERFORMANCE IN RISING AND FALLING INFLATION REGIMES
Unconditional* – Fully invested in the asset class regardless of the inflation directionality
Rising* – Higher investment in CBs proportional to the prevalence of the rising inflation surprises as part of the CBs/Cash asset mix
Falling* – Higher investment in CBs proportional to the prevalence to the falling surprises as part of the CBs / Cash asset mix
*See the end of insight for full details of the Economic Regime Affinity process
PERFORMANCE IN RISING AND FALLING GROWTH REGIMES
Unconditional* – Fully invested in the asset class regardless of the growth momentum
Rising* – Higher investment in CBs proportional to the prevalence of the increase in GDP surprises as part of the CBs / Cash asset mix
Falling* – Higher investment in CBs proportional to the prevalence of the decrease in GDP surprises as part of the CBs / Cash asset mix
*See the end of insight for full details of the Economic Regime Affinity process
Even when there was a stumble in convertibles’ performance, they showed almost 50% less volatility than comparable basket of equities, almost double the risk/reward ratio and around an 18% reduction in the drawdown magnitude, if you take 2015 to 2025 as an investment window (see the charts below). How cool is that?
Sill not convinced? Tough crowd, I get it. How about today’s ‘mega themes’ that keep evolving and overtaking each other in their prominence at a breakneck speed, such as Crypto and AI. Convertibles lend themselves well to the issuance for innovative companies seeking to finance their efforts and in return allow the market participants to ride the wave of innovation in technology spree, which in turn support the asset class performance when the cycle dips.
Finally, remember those cool kids that I mentioned before? Allow me to quote from a love letter (yes, you read this right) written by someone who knows his convertibles: ‘The playful siblings of Ubisoft mingle with the soldiers of Rheinmettal, the scientists of Qiagen can exchange with the researchers of Idorsia. The elegant distillers of Remy Cointreau accompany the financiers of Nexi or the environmental visionaries of Neoen. The industrials of SGL Carbon, who undoubtedly travel with the stewards and pilots of Air France-KLM, also use the services of Edenred. All these voices strangely form a delightful symphony where the techies of STM and the convertible trios of Cellnex towers, the factories of Be Semiconductor, or the chemists of Evonik are added.’ There is more where this came from, here is the link to the full post.
So, given all the benefits you get from such a versatile asset, do not leave home without your convertible bonds. What are you waiting for? Ask asset manager when they will re-invest (if you ever left) or invest in this amazingly versatile asset class. If they don’t know where to start, come and speak to us at FTSE Russell. We’ve been tracking the convertibles markets for a couple of decades and are happy to support them and you on the way to (re-)discovering all that convertible bonds can offer.
1 year performance
5 years performance
10 years of peformance
20 years+ of the performance
* ‘Economic Regime Affinity’ charts: Convertible Bonds in Inflation and Growth Economic Regimes charts are intended and constructed to test the asset class’s performance sensitivity to inflation and growth factors. Inspired by Ilmanem (2014), we define an inflation “up” regime when the monthly published inflation reading exceeds the previous 12-month average. Similarly for all the other regimes (inflation down, growth up and growth down). Macroeconomic data is backward looking and published with lags, while asset prices are forward looking. To properly capture the macro sensitivity of the asset prices we use the 6-month ahead average of the macro regime to build an up and down regime strategy. The up (Rising) strategy invests in convertibles (proxied by the FTSE Global Focus Index) proportionally to the prevalence of positive surprises during the 6-month period, the rest is kept in cash. The down strategy (Falling) invests in convertibles proportionally to the prevalence of negative surprises during the 6-month period, the rest is kept in cash. Due to the lookahead, these strategies are not intended as back tests for the allocation but to assess the performance of the asset class in different macro regimes. This ‘Economic Regime Affinity’ testing’[2] approach was designed to test the ‘common knowledge’ of an asset class behaviour in different economic regimes.
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