Geopolitical tensions have eased somewhat and a deal between the US and China seems closer every day. Meanwhile, macroeconomic data has started to show signs of bottoming, and sentiment has improved. The main business climate index of the November German IFO survey came out 0.3 points up, to 95.0, due to unchanged current conditions and modestly improved expectations.
PMI services have managed to stay broadly in expansion territory. Overall, the evolution of the JP Morgan Global PMIs appears to suggest the underlying pace of activity is improving at the global level, even if the level remains soft.
Against this backdrop, and buoyed by less uncertainty and more accommodative sentiment, the Santa rally has come early this year.
Global market outlooks also point to more optimistic positioning. Indeed, our tactical asset allocation approach for the next few weeks has turned back toward positive risk assets. Nevertheless, markets remain prone to “flip flop” moves due to trade talks. A middle approach could be most suitable course of action: find some protection and stay invested. To that end, global convertible bonds remain an interesting alternative.
Global convertible bonds for the current market
With similarities to both bonds and equities, convertible bonds offer investors diversified exposure, asymmetric participation and potential protection on the downside.
As markets have rallied, the Thomson Reuters Qualified Global Convertible Bond Index has returned close to 3.7% during the past three months (in USD unhedged terms). This performance is partly due to the equity sensitivity (delta), which is currently at 0.47 versus a long-term mean of 0.45. That delta indicates a strong ability to participate in a further relief rally if trade discussions eventually come to a better outcome.
In the event of a pullback , the bond floor would also help protect portfolios. Meanwhile, with yields already low, interest rate sensitivity is less of a worry for now. However, the duration of the exposure is “only” 3.8 and its Rho (or rate sensitivity including the equity option price) is -1.88 for a 100bps parallel shift increase in the underlying treasury curves. The convexity provided by the exposure can be a good way to stay invested and protect against headline volatility in the near term due to trade negotiation and UK elections.
Finally, another advantage of global convertible bonds is their different sector distribution compared with a more traditional global volatility equity fund. With more technology exposure and less rate-sensitive value sectors, convertible bonds may be an interesting diversifier in the current markets.