The Right Way to Think About Convertibles—And What They Can Do for Clients in 2021

Convertible securities (as represented by the ICE BofA All U.S. Convertibles Index or VXA0) were up 46.22% in 2020 and outperformed every other major asset class. At this point, the natural inclination might be to wait for a pullback before investing. But, says Calamos Co-Portfolio Manager Joe Wysocki, “We think that's just, structurally, the wrong way to think about convertibles.”

Calamos believes the right way to think about convertibles, he says, is to focus on their strategic benefit as a core allocation: “Through full market cycles, the ups and the downs, you have the opportunity to compound wealth over time, compound those returns, and you can get equity-like returns or better through many of those cycles.”

Convertibles provide the opportunity to participate in equities’ upside, coupled with the ability to mitigate the risk of equities’ downside.

CICVX Recovered Quicker

Below Wysocki looks at 2020 and two other market corrections—the S&P 500 after the tech bubble burst in 2000 and after the 2008-2009 financial crisis. The speed and magnitude of what happened in 2020 was unlike what happened previously as both earlier crises took years to recover. But in each occasion, he notes that the Calamos Convertible Fund (CICVX) had recovered—and with double-digit returns—well before the S&P 500 went on to make new highs.

Now What?

As they have historically, convertibles in 2020 proved themselves to be a valuable asset class during and after a market correction. But as we start the new year, equity markets are at all-time highs and the underlying equities of some convertible issuers have doubled and tripled.

Here, too, Wysocki acknowledges that some investors may mistakenly believe this heightens the risk of an especially equity-sensitive convertible market. “Just remember that converts are an actively managed asset class,” he stresses.

As active managers, the Calamos team thinks about the convert market in different buckets:

• The yield alternative or busted-type convertibles
• Total return alternatives, which Calamos considers the sweet spot
• Equity alternatives, where the equities have appreciated, converts have participated, but there’s little downside protection.

The table below shows a few snapshots of the composition of the convertible market as a whole. “Things can move fast,” comments Wysocki, noting that 40% of the market was in busted converts last March, reduced to 19% by November. “Taking advantage of volatility and rebalancing between convertible structures can be a useful tool to maintain a consistent risk/reward profile.”

With 41% of the market in the total return segment, the team sees ample opportunity for balanced convertibles in today’s market. Last year’s strong new issuance—including from about 100 new issuers—has provided broader opportunities in areas the team likes. Converts can be an effective way to diversify growth, Wysocki adds. More than half of issuers are below $20 billion in market cap, and convertibles have a reputation for supporting tomorrow's market leaders.

While issuance overall may decelerate from 2020’s record-setting pace, demand is expected to continue as companies prefer convertibles as a financing vehicle. Finally, Wysocki looks ahead to the return of rising rates. That’s another environment when convertibles have performed well.

Investment professionals, for more on CICVX, contact your Calamos Investment Consultant at 888-571-2567 or caminfo@calamos.com.

Click here to view CICVX's standardized performance.