Convertible Market Overview

Accommodative monetary and fiscal policies allowed the U.S. economy to transition from rapid recovery in 2003 to steady expansion in 2004, providing corporations with a favorable environment to improve balance sheets and deliver continued, albeit slower, growth. Even though this backdrop was quite favorable for equity markets, convertibles were still able to keep pace with broad stock market measures such as the S&P 500 Index and exceed the Dow Jones Industrial Average for the year.

This past year saw continued lower volatility in the equity markets and an overall low interest rate environment, both of which tend to restrict returns on convertibles. As for yields, the measured increases that the Fed has undertaken to raise the Fed Funds target from 1% to 2.25% has certainly raised the level of yield that convertible issuers must offer to be competitive, but has still left the entire fixed income market in a relatively low interest rate environment. One of the potential upsides to this environment is that an increase in either volatility or interest rates (preferably due to continued GDP growth) could help boost the performance of convertible securities in the future.

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