The first quarter of 2016 has provided a bumpy ride on markets worldwide, which is likely to have set a pattern for the rest of the year. In a period of uncertainty and volatility, convertible bonds have an opportunity to demonstrate their worth.
Investors in equity markets have had to contend with considerable uncertainty over the course of the first quarter of 2016. Although markets fared better in late February and March after record lows in January, it would seem the maxim ‘expect the unexpected’ will continue to ring true in Q2 and throughout the remainder of the year.
The next three months will be dominated by a period of heightened volatility ahead of the UK referendum on its continued membership of the European Union (EU) on 23 June. With polls expected to remain tight in the run-up to the vote, uncertainty around the outcome will dent market confidence. Moreover, despite more positive developments recently, a number of additional macroeconomic uncertainties could yet trigger a further drop in markets.
With the possibility that current market dynamics will not run their course anytime soon, equity investors the world over are understandably reviewing their portfolios with the aim of minimising risk over the remainder of the year.
At a time of such uncertainty, convertible bonds do exactly that with the asset class having a history of performing well during market downturns. In the extreme case of the 1929 Wall Street crash companies with strong profiles – such as General Electric (GE) and Western Union – with a track record of issuing convertible bonds, supported investor returns during a difficult economic period. In its essence a convertible bond provides a safety net to investors with the potential for significant upside when share prices rise and can be a valuable tool in any portfolio.
Strength of convertibles
There is also an established and growing set of companies across Europe which regularly issue convertible bonds. Moreover, they are an attractive option for high-growth companies wishing to finance with the lowest possible running costs. It is also expected that the European insurance industry will be increasingly drawn towards the asset class as a result of new Solvency II capital adequacy requirements.
However, many still regard convertible bonds with scepticism. For some companies they are seen as a complex way to raise funds – particularly in such a low interest rate environment as at present, while for institutional investors unfamiliarity with the asset class can be an obstacle.
Moreover, with sustained uncertainty seemingly the trend for the remainder of 2016, investor interest will be stirred by any asset class with potential to mitigate downside risk when equity markets fall. Importantly for investors, the convertible bond asset class continues to evolve and new structures are bringing companies to this market for the first time.
Like all investment decisions, detailed research is required and a solid understanding of the convertible bond market is vital. Active management is also crucial in order to maximise returns over time.
In such an uncertain climate, investors should be open to exploring new ways to deliver returns as pressure intensifies amidst pension shortfalls. For investors with such a mind-set, a consideration of the potential of convertible bonds could be worthwhile as they attempt to maximise returns.