09 March 2020
Chinese Caixin Composite PMIs cratered to 27.5 last week. Then we saw surprisingly positive numbers from the US ISM Manufacturing at 57.3 (versus 54.8 expected) and better than expected European PMIs, buoyed by an emergency 50bps cut by the US Federal Reserve on Tuesday 3 March, followed by the Bank of Canada on 4 March. Markets have rallied further on Democratic candidate Joe Biden’s revival after strong Super Tuesday results.
Investors welcomed the respite after a challenging end of February that saw six consecutive days of falling equity markets and outflows from both high yield and corporate bond ETFs (c. $7 billion in the week of 24-28 February).
In the current environment, global convertible bonds have provided a key source of volatility protection within investors’ portfolios. As uncertainty remains around the severity of the coronavirus and its impact on global GDP growth, we expect that the profile of convertible bonds may continue to help investors as markets brace for more volatility in the year ahead. We may see unnerving economic data prints in the coming weeks as growth expectations get revised and markets continue to trade on coronavirus headlines.
Global Convertible Bonds: 2020 Update
- A central theme shared amongst investors is aiming to reduce exposure and delta risk, while still remaining exposed to underlying convertible equities, which have continued to show resilience and growth opportunities this year.
- Year to date, global convertible bonds have returned -0.20% versus -9.09% (Thomson Reuters Qualified Global Convertible Bond Index USD versus MSCI ACWI Index USD) as of end-February 2020.
- Convertible bonds have also partially protected investors versus high yield, outperforming the USD index by 120bps.
- The sell-off in the market has allowed premia to contract and has offered investors an opportunity to join the exposure at reduced delta levels with the potential to protect further against market/macro volatility.
- Overall, the asset class has helped insulate investors from the equity pull-back, with a spate of bonds outperforming since the start of the year. Such names include Tesla (+47.2%), Semiconducting Manufacturing (+22.3%), Ring Central (+34.9%) and Service Now (+12.4%).
- On the other hand, certain names have been hurt by the current market conditions, such as NMC Health Jersey Ltd (-40.1%), Intelsat (-36.1%) and Chesapeake Energy (-2.2%). But their contribution was lower as they account for 0.33% of the portfolio versus 4.85% for the 3 top issuers mentioned above.
- Finally, in each of the past periods where the VIX has broken through 25 (c. +1 standard deviation), convertible bonds have shown the specific protection they can provide through convexity. In the last week of February, the Thomson Reuters Qualified Global Convertible Index tracked by our ETF only fell by -4.8% versus -10.4% for the ACWI (global equities) index. The below graph shows the weekly performance in USD unhedged terms of the convertible index versus the global equity index for each level of VIX.