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Insight 26.05.2017

The time is right for convertible bonds

The time is right for convertible bonds

The beginning of a trend


Key points

  • With already two interest rate hikes in only 3 months in the US and more to be expected this year, investors are looking for alternatives to their bond investments. 
  • When faced with a rise in interest rates, convertible bonds’ embedded option acts as a safety cushion, partially offsetting the negative impact on the bond component. 
  • History has shown that when rising interest rates was paired with ad-ditional equity performance, convertible bonds could not only deliver positive performance but, in some cases, even outperform equities. 
  • The ECB’s extensive asset purchase program has pushed prices upwards in credit markets across Europe. In contrast, convertible bonds have remained preserved from this massive distortion effect. 
  • Although a tightening trend has also started in the convertible space, at current spread levels, they still have much higher value potential to offer than comparable straight bonds. 
  • Over the past months, the combination of convertible bonds’ key differentiating features has enabled them to significantly outperform straight bonds. 
  • We believe this is only the beginning.

The beginning of a trend

As widely expected, the Fed hiked its key rates by 25bps during its March FOMC meeting, on the back of recent solid equity markets’ performance, firming growth indicators and rising inflation data. On this occasion, the US Fed chairman, Janet Yellen, reiterated that further increases should be expected this year.

While this is more imminent issues for US investors, European fixed income markets are not immune to the risk of rising interest rates. As indicators and growth outlook continue to improve in the Eurozone, an appeasement of political risks could lead the ECB to adopt a more neutral monetary policy stance over the course of the year, with a possible shift in communications over the summer months. On April 27th, while keeping rates unchanged, ECB President Mario Draghi yet acknowledged the vigor of the Eurozone economy.

For investors looking for alternatives to their bond investments, current environment points towards convertible bonds.

An efficient hedge against rising interest rates? History points the way

When faced with a rise in interest rates, convertible bonds' embedded option acts as a safety cushion, partially offsetting the negative impact on the bond component. This comes from the fact that equity options are positively correlated to interest rate moves. As such, they usually provide positive returns when interest rates rise.

Looking back at periods when the yield of the 10Y-Bund (in Europe) or of the 10Y-US Treasury soared by more than 120bps over the past 20 years, figures speak for themselves. During each of these 11 periods (3 in Europe and 8 in the US), not only convertible bonds outperformed systematically straight bonds but they were also systematically positive whereas straight bonds were systematically negative in absolute terms.

History has shown that when rising interest rates was paired with additional equity performance, convertible bonds could not only deliver positive performance but, in some cases, even outperform equities.

Read More

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Nicolas Delrue
Head of Investment Specialists &
Convertible bond Senior Investment Specialist

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Scarlett Claverie-Bulté
Convertible Bond Investment Specialist

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Euro area inflation confirmed the preliminary estimate, German Q4 GDP was in line

Eurozone: CPI (Jan F): 1.3% m/m as expected (prior: 1.3%)

  • On a m/m basis: -0.9% as expected (prior: 0.4%)
  • CPI core y/y: 1% as expected (prior: 1%)
  • Services inflation, which provides the best read in the initial report on domestically generated price increases, was unchanged from the initial report as well as from the December reading of 1.2%.

 

Germany: GDP (Q4 F): 0.6% q/q as expected (prior: 0.6%)

  • On a y/y basis: 2.3% as expected (prior: 2.3%)
  • Growth momentum in Q4 was mainly supported by foreign trade. Exports grew substantially by 2.7% q/q, while imports were also up by 2% q/q.
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  • On the investment side, gross fixed capital investment remained flat, with construction declining slightly.

 

Poland: Unemployment rate (Jan): 6.9% as expected (prior: 6.6%)

Market insight 22.02.2018

Business confidence slightly lower in France and Germany

US: Initial jobless claims (Feb. 17): 222k vs 230k expected (prior: 229k revised from 230k)

  • Initial jobless claims continue to flirt with multi-decade lows.

 

Germany: IFO (Feb.): 115.4 vs 117.0 expected (prior: 117.6)

  • Expectations: 105.4 vs 107.9 expected (prior: 108.3)
  • Current assessment: 126.3 vs 127.0 expected (prior: 127.8)
  • Despite falling below the 12-month average (115.7), the headline index remains elevated from a historical perspective.
  • This adds to evidence that GDP growth is probably nearing its peak, but also that the economic momentum should remain strong.

 

France: Business confidence (Feb.): 109 vs 110 expected (prior: 111 revised from 110)

  • Slightly down for the second consecutive month.
  • Like yesterday's PMIs, both the manufacturing and services sector indices edged lower but nonetheless remain at very healthy levels.

 

UK: GDP (Q4 Prel.): 0.4% q/q vs 0.5% expected (prior: 0.5%)

  • GDP y/y: 1.4% vs 1.5% expected (prior: 1.8%)
  • Q4 GDP was revised a tad lower to 0.4% q/q from 0.5% q/q.
  • The expenditure breakdown shows resilient consumption at 0.3% q/q (after 0.4% in Q3) while business investment continued to slow (from 0.5% q/q to flat in Q4). This suggests that corporates are holding back investment in the face of high levels of uncertainty regarding the outlook for business conditions.
Market insight 20.02.2018

ZEW slightly lower than expected in Germany

Germany: Zew (Feb): 92.3 vs 93.9 expected (prior: 95.2)

  • Expectations: 17.8 vs 16 expected (prior: 20.4)
  • Sentiment has slightly eased, probably more due to the recent decline in equity prices rather than broader concerns about the economy.

 

Germany: PPI (Jan): 0.5% m/m vs 0.3% expected (prior: 0.2%)

  • On a y/y basis: 2.1% vs 1.8% expected (prior: 2.3%)
  • Consumer goods prices rose by 0.1% m/m, while capital goods prices increased by 0.5% m/m.

 

Poland: PPI (Jan): 0.1%m/m vs 0% expected (prior: -0.3%)

  • On a y/y basis: 0.2% vs 0.1% expected (prior: 0.3%)
  • Manufacturing rose by 0.2% m/m, while electricity and gas declined by 0.3% m/m.

 

Poland: Retail sales (Jan): -20.5% m/m vs -21.2% expected (prior: 16.6%)

  • On a y/y basis: 8.2% vs 6.9% expected (prior: 6%).

 

Further reading

Market insight 23.02.2018

Euro area inflation confirmed the preliminary estimate, German Q4 GDP was in line

Eurozone: CPI (Jan F): 1.3% m/m as expected (prior: 1.3%)

  • On a m/m basis: -0.9% as expected (prior: 0.4%)
  • CPI core y/y: 1% as expected (prior: 1%)
  • Services inflation, which provides the best read in the initial report on domestically generated price increases, was unchanged from the initial report as well as from the December reading of 1.2%.

 

Germany: GDP (Q4 F): 0.6% q/q as expected (prior: 0.6%)

  • On a y/y basis: 2.3% as expected (prior: 2.3%)
  • Growth momentum in Q4 was mainly supported by foreign trade. Exports grew substantially by 2.7% q/q, while imports were also up by 2% q/q.
  • In terms of the domestic components, public consumption remained resilient in H2 17, Q3 growth has been revised up to 0.5% q/q (+0.5 ppt), in line with Q4 17 print (0.5% q/q).
  • On the investment side, gross fixed capital investment remained flat, with construction declining slightly.

 

Poland: Unemployment rate (Jan): 6.9% as expected (prior: 6.6%)

Market insight 22.02.2018

Business confidence slightly lower in France and Germany

US: Initial jobless claims (Feb. 17): 222k vs 230k expected (prior: 229k revised from 230k)

  • Initial jobless claims continue to flirt with multi-decade lows.

 

Germany: IFO (Feb.): 115.4 vs 117.0 expected (prior: 117.6)

  • Expectations: 105.4 vs 107.9 expected (prior: 108.3)
  • Current assessment: 126.3 vs 127.0 expected (prior: 127.8)
  • Despite falling below the 12-month average (115.7), the headline index remains elevated from a historical perspective.
  • This adds to evidence that GDP growth is probably nearing its peak, but also that the economic momentum should remain strong.

 

France: Business confidence (Feb.): 109 vs 110 expected (prior: 111 revised from 110)

  • Slightly down for the second consecutive month.
  • Like yesterday's PMIs, both the manufacturing and services sector indices edged lower but nonetheless remain at very healthy levels.

 

UK: GDP (Q4 Prel.): 0.4% q/q vs 0.5% expected (prior: 0.5%)

  • GDP y/y: 1.4% vs 1.5% expected (prior: 1.8%)
  • Q4 GDP was revised a tad lower to 0.4% q/q from 0.5% q/q.
  • The expenditure breakdown shows resilient consumption at 0.3% q/q (after 0.4% in Q3) while business investment continued to slow (from 0.5% q/q to flat in Q4). This suggests that corporates are holding back investment in the face of high levels of uncertainty regarding the outlook for business conditions.
Market insight 20.02.2018

ZEW slightly lower than expected in Germany

Germany: Zew (Feb): 92.3 vs 93.9 expected (prior: 95.2)

  • Expectations: 17.8 vs 16 expected (prior: 20.4)
  • Sentiment has slightly eased, probably more due to the recent decline in equity prices rather than broader concerns about the economy.

 

Germany: PPI (Jan): 0.5% m/m vs 0.3% expected (prior: 0.2%)

  • On a y/y basis: 2.1% vs 1.8% expected (prior: 2.3%)
  • Consumer goods prices rose by 0.1% m/m, while capital goods prices increased by 0.5% m/m.

 

Poland: PPI (Jan): 0.1%m/m vs 0% expected (prior: -0.3%)

  • On a y/y basis: 0.2% vs 0.1% expected (prior: 0.3%)
  • Manufacturing rose by 0.2% m/m, while electricity and gas declined by 0.3% m/m.

 

Poland: Retail sales (Jan): -20.5% m/m vs -21.2% expected (prior: 16.6%)

  • On a y/y basis: 8.2% vs 6.9% expected (prior: 6%).