Convertible Market
A late January rebound in the U.S. convertible1 market, which followed cuts in the Federal funds rate that totaled 125 basis points, was not enough to turn around earlier losses. The convertible market2 declined 1.91% compared with a larger decline of 6% in the S&P 500 index. The limited losses versus the broader stock market showed the benefits of the hybrid nature of convertibles in another volatile month.
Monthly Returns (as of 1/31/08)
The hybrid nature of convertibles allows them to participate in upside returns and helps to limit downside risk.
Source: Russell Analytics
Credit Quality
Investment grade convertibles proved their resilience in this turbulent market as the Merrill Lynch All Investment Grade Index (VXA1) outperformed the All Speculative Grade Index (VXA2) by 180 basis points. Investment-grade convertibles started outperforming in the second half of 2007 because of concerns over a credit crunch and its potential drag on the U.S. economy. Calamos is biased toward high-quality convertibles from issuers with low debt and strong growth prospects.
Investment/Speculative Grade Comparison
Investors continued in January to reappraise their tolerance for risk in the turbulent market and they were drawn higher-quality convertible bonds. (Returns are cumulative, since 1/31/07)
Source: Bloomberg LP, Merrill Lynch
Sector Performance
For the month, companies in the financial sector claimed the top spot with a return of 3.3%, supported by the strong primary market issuance in the capital-thirsty financial sector and an accelerated pace in Fed easing. We are selective within this area given the risk exposures faced by many financial companies. The consumer discretionary sector also managed to end in positive territory for the month. Cyclical sectors such as industrials, energy and materials performed poorly and we remain cautious about such companies given their valuations after years of gains.
January Sector Returns
As investors see more possibility of recession, economically sensitive sectors such as energy and utilities performed poorly in January.
Source: Merrill Lynch
Outlook
We believe the market pullback will help increase investor focus on the importance of investing in sustainable growth, less leveraged companies in an environment of slower economic growth. Valuations in many sectors are now pricing in a recession or almost no growth. Nonetheless, our belief remains that there are enough growth engines around the world to continue to support the global expansion we have seen during this decade.
Past performance is no guarantee of future results. Current performance may be lower or higher than the performance quoted.
Index Definitions
The U.S. convertible market is represented by the Merrill Lynch All Convertible Index (VXA0), which is comprised of approximately 700 issues of only convertible bonds and preferreds of all qualities. The U.S. stock market is represented by the S&P 500 Index, an unmanaged index generally considered representative of the domestic large-cap stock market. The Merrill Lynch All Investment Grade Index (VXA1) includes about 140 convertible securities with investment-grade credit ratings to represent the investment-grade convertible market. The Merrill Lynch All Speculative Grade Index (VXA2) includes about 270 convertible securities and represents the non-investment grade convertible market.
Unmanaged index returns assume reinvestment of any and all distributions and do not reflect fees, expenses or sales charges. Investors cannot invest directly in an index.
There are certain risks associated with an investment in a convertible bond such as default risk—that the company issuing a convertible security may be unable to repay principal and interest—and interest rate risk—that the convertible may decrease in value if interest rates increase.
This commentary is presented for informational purposes only and should not be considered investment advice.
1Convertible bonds are interest-paying securities, similar to corporate bonds, in which investors have the option to turn the bonds into a predetermined number of shares. The hybrid nature of the securities offers investors the principal-protection and income characteristics of bonds with the opportunity for higher returns if the issuer's stock price rises.
2As measured by the Merrill Lynch All Convertibles Index (VXA0)
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