Finding Attractive Convertible Opportunities … and Likely More on the Way

Jon Vacko, CFA, and Joe Wysocki, CFA

Summary Points:

• Calamos Convertible Fund is invested in companies we believe are positioned to benefit from long-term growth themes, in areas such as artificial intelligence, productivity enhancements and cybersecurity.
• We believe the current economic growth, inflation and monetary policy trajectories set up well for small-cap and mid-cap companies, which are mainstays in the convertible market.

The first quarter of 2024 saw a continuation of strong equity markets. The S&P 500 reached an all-time high, largely driven by better-than-expected economic US growth and the lack of a resurgence of inflationary pressures. 

Given these trends, one of the more frequent debates recently has focused on when the Fed will cut interest rates. In our view, what matters more than the timing of rate cuts is that the Fed is relatively well positioned to adjust policy as needed.

We are cautiously optimistic that economic growth, inflation, and monetary policy will continue to normalize along their current trajectories, which can provide a further tailwind for risk assets and potentially a broadening of equity market leadership. However, we are prepared for volatility to increase. Markets will scrutinize every Fed action, and this year’s US presidential election is likely to be quite contentious with fiscal policy implications for years to come.

Within Calamos Convertible Fund (CICVX), our overall focus remains on bottom-up company selection and actively managing security-specific risk/reward tradeoffs. A broadening out of equity market leadership could be particularly beneficial for small-cap and mid-cap growth companies, which are well represented in the convertible universe. We maintain our preference for balanced convertible structures that provide favorable asymmetric payoff profiles by offering potentially attractive levels of upside equity participation with less exposure to downside moves.

Technology, health care, and consumer discretionary continue to be CICVX’s largest sector allocations, as they were at the start of the quarter. As we have discussed in the past, we favor companies that are executing well despite macro uncertainties, with improving margins and free cash flow, accelerating returns on invested capital, and attractive equity valuations. We also focus on identifying innovative companies positioned to benefit from cyclical and secular themes that can serve as tailwinds to individual corporate performance. These include companies advantageously positioned as businesses seek solutions to higher labor, manufacturing, and interest costs in the current economic environment, as well as companies exposed to trends such as artificial intelligence, productivity enhancements, and cybersecurity. We expect the convertible market will provide opportunities to participate in these fast-growing trends for years to come.

The convertible new-issue market continued to be strong into the first quarter, with US issuance up approximately 50% relative to the same period in 2023. The continuation from 2023 of more investment-grade-rated securities, higher coupons and lower conversion premiums bodes well for convertible investors. A significant amount of this year’s issuance has been brought to market to refinance existing debt, which we believe demonstrates the appeal that convertibles hold for issuers.

We remain optimistic about issuance prospects going forward as companies increasingly recognize the lower-borrowing-cost benefits of convertibles in lieu of traditional bonds in an environment of higher interest rates. We believe that the combination of a sizable amount of debt maturing in 2025 across bond markets, the possibility of a higher-for-longer interest rate scenario, and the fact that convertibles have served as growth capital for leading small and midcap companies throughout the full business cycles should serve as accelerants for continued solid issuance.