Insights


Relief rally or more volatility ahead? Staying invested with convertible bonds

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.

Fig 1: Thomson Reuters Qualified Global Convertible Index vs. MSCI ACWI – Weekly Performance Per VIX Level


Source: State Street Global Advisors, Bloomberg Finance L.P., as of 28 February 2020. Performance in USD unhedged. Past performance is no guarantee of future results. It is not possible to invest directly in an index. Index performance does not reflect charges and expenses associated with the fund or brokerage commissions associated with buying and selling a fund. Index performance is not meant to represent that of any particular fund.

Valuations have also become relatively more attractive as markets fell, with deltas back to their longer-term average and implied volatility cheapening slightly.


Fig 2: Thomson Reuters Qualified Global Convertible Index – Delta Evolution


Source: State Street Global Advisors, Thomson Reuters, as of 28 February 2020. The Thomson Reuters Qualified Global Convertible Index was incepted on 10 December 2008. Results prior to this date were calculated by using available data at the time in accordance with the Index’s current methodology. Thomson Reuters Qualified Global Convertible Bond Index (TR) includes back-tested returns supplied by Thomson Reuters.


Fig 3: Thomson Reuters Qualified Global Convertible Index – Implied Volatility Evolution


Source: State Street Global Advisors, Thomson Reuters, as of 28 February 2020. The Thomson Reuters Qualified Global Convertible Index was incepted on 10 December 2008. Results prior to this date were calculated by using available data at the time in accordance with the Index’s current methodology. Thomson Reuters Qualified Global Convertible Bond Index (TR) includes back-tested returns supplied by Thomson Reuters.

As we brace for potentially prolonged periods of volatility but remain aware of the risk of not being invested if markets fully recover from their trough, global convertible bonds may be an exposure to consider to navigate gyrating performance dynamics.


Fund Details


Source: State Street Global Advisors, S&P Dow Jones Indices LLC, as of 28 February 2020. Characteristics are as of the date indicated and should not be relied upon as current thereafter.


Flows


European-Domiciled ETP Segment Flows (Top/Bottom 5, $mn)

European-Domiciled ETP Asset Category Flows ($mn)

Sources: Bloomberg Finance L.P., for the period 27 February – 5 March 2020. Flows are as of date indicated and should not be relied upon as current thereafter


Performance (annualised, expressed in base currency - USD)


Source: State Street Global Advisors, as at 28 February 2020. Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. The contained performance data do not take account of the commissions and costs incurred on the issue and redemption, or purchases and sale, of units. Visit ssga.com for most recent month-end performance. The performance figures contained herein are provided on a net of fees basis. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Performance returns for periods of less than one year are not annualised. Some of the products are not available to investors in certain jurisdictions. Please contact your relationship manager in regards to availability.


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Footnotes

1Returns are as of 28 February 2020. This information should not be considered a recommendation to invest in a particular sector, or securities therein, shown above.

2Returns are as of 28 February 2020. This information should not be considered a recommendation to invest in a particular sector, or securities therein, shown above.