Convertible Market in High Gear: A Look at What’s Under the Hood

A Q&A with John P. Calamos, Sr.
Founder, Global Chief Investment Officer

Key Points

• The convertible market has long been the choice of growth companies; we see this today in the strong representation of AI names.
• The convertible structure provides opportunities to invest in growth companies with less potential downside than equities—an attractive proposition as approaching midterms increase fiscal policy uncertainty.
• Active management is essential for capitalizing on the opportunity of convertibles, according to John P. Calamos, Sr.

It’s no surprise that investor interest in convertible securities is soaring. Convertibles have outperformed equities over the past year,¹ and a surge of new issuance has included many exciting companies at the forefront of AI.

To learn what’s happening under the hood—and what’s on the horizon—we sat down with John P. Calamos, Sr., the founder and global chief investment officer of Calamos Investments. Between his 50+ years of pioneering experience with convertibles—including authoring two books on the subject—and the firm’s $14.3 billion of convertible assets under management,² John brings unmatched perspective.

Q. John, the convertible market is capturing the attention of more investors, including many who are considering convertibles for the first time. What’s your take?

A. It’s great to see this rising interest in convertibles, and I hope it continues. Convertibles can be a tremendously powerful addition to an asset allocation.

When I first started learning about convertibles in the late 1960s, they were essentially an alternative asset class, even within the investment community. In fact, one of the reasons I founded Calamos Investments in the 1970s was to provide more people with access to convertibles.

Convertibles can provide many advantages that stocks and bonds can’t. They can be a powerful tool for accessing growth potential with lower downside risk. They can also serve as an alternative to traditional fixed income, with less exposure to interest rate risk.

Q. A lot of the excitement around convertibles has centered on the new issuance market. Walk us through what you’re seeing.

A. Right now, the global convertible market is in a period of remarkable issuance. Year-to-date, we’ve seen $144.4 billion come to market through July, which is on pace to shatter last year’s record issuance of $167 billion. This year has already seen the largest single issuance ever, from mega-cap tech powerhouse Alphabet (Google).

Convertible issuance is about capital market access. The convertible market is home to lots of different companies across sectors and market caps, but growth-oriented companies have tended to be very well represented. That’s been the case for more than 150 years. The first convertibles were issued by US railroad companies in the mid-1800s—when railroads were a growth industry and the US was an emerging market!

Today’s convertible market continues to offer access to high-growth opportunities. Investors are especially enthusiastic about the many AI names that have issued convertible securities over the past couple of years.

Q. Are there any misconceptions about convertibles in the broader investment community?

A. Unfortunately, yes. Although convertibles are much better understood today than in the past, the mechanics of convertibles are still not always well understood. It’s not simply the convertibles that make a strategy work but how they are managed. That’s why I believe so strongly that active management and bottom-up research are key to selecting the right convertibles for a particular strategy.

There’s a lot of variation among convertibles in terms of risk-reward. In the simplest terms, a convertible bond is a fixed-income security that includes an embedded option to convert the bond into a predetermined number of shares of the issuer’s underlying equity at a set price. The convertible’s equity characteristics—the conversion feature—provide the opportunity for equity market upside. Bond-like characteristics—the coupon and maturity date—can provide a cushion against equity market downside.

Active management matters because some convertibles have higher levels of equity sensitivity, and some are more bond-like. These characteristics are always changing, both for individual convertibles and for the convertible market as a whole—this means the risk-reward is always changing. Also, there are different types of convertible structures—for example, some convertibles include mandatory call features. These mandatory convertibles can be particularly sensitive to changes in their underlying equities.

Q. What are some key points to keep in mind about convertibles in the AI space?

A. First, it’s important to remember the convertible market includes more than AI—it’s also home to companies involved in everything from defense and aerospace to asset management to online retail to pharmaceuticals.

That said, there’s no doubt that AI names are a force in the convertible market, and what we’re seeing today illustrates some of the opportunities that convertibles can provide and some of the complexities. Convertibles can be an attractive way to access high-growth opportunities—like AI names—because the convertible structure can shift the risk-reward needle in a way that many investors really appreciate.

But recall what I mentioned about equity sensitivity and how it changes—over time for an individual convertible as well as for the market as a whole. Right now, many of the AI convertibles have higher levels of equity sensitivity relative to convertibles in other areas of the market, which makes sense given their high growth potential. This is also contributing to a higher level of equity sensitivity in the convertible market overall, and higher equity sensitivity means the market may swing more steeply than in other periods, especially in the short term.

So again, this is why active management matters. You have to monitor the fundamentals of the companies, the larger drivers of AI opportunity, and the macro landscape. It’s a long list. Our portfolio managers are continually weighing the upside-downside of AI names against opportunities across the market.

Q. You mentioned the macro landscape. How much upside in the convertible market do you see from here?

A. With any asset class, the securities you select matter more than how the market is performing. We’ve been investing in convertibles for decades, and we don’t believe we need a rising market to capture the benefits of convertibles.

I think the better question to ask is if the case for convertibles is strong. And in my view, the answer is yes, the case for actively managed convertibles is very strong. The world is in the midst of unprecedented change and disruption because of AI, which will create opportunities for growth companies not just in tech but also across industries. And of course, there are other growth themes that are driving opportunity, like defense and security. Convertibles provide a great way to participate.

But even though I am optimistic about growth and innovation, I believe investors should be prepared for elevated volatility ahead. Under any circumstances, it’d be quite normal for the market to pause after an extended run, but with midterms coming up, there’s every reason to brace for turbulence—markets recognize that election results will have a big impact on the direction of fiscal policy and the trajectory of the economy.

Q. For investors who want to add convertibles, what should they be thinking about?

A. Convertibles can enhance asset allocation in lots of ways. We have several strategies designed to provide lower-volatility equity participation over full market cycles. These portfolios invest primarily in convertibles or combine convertibles with stocks and other asset classes. Under this broader lower-volatility umbrella, we’ve tailored our portfolios to meet a range of risk-reward goals. Convertibles can also be used as an alternative to traditional fixed income strategies—for example, our flagship market neutral income strategy uses convertible arbitrage as a core strategy to pursue bond-like returns with little exposure to interest rate risk.

Above all, it’s important to be mindful of your own risk tolerance. Markets can bounce around in the short term—and the convertible market is no exception. Having long-term perspective and approaching your convertible allocation strategically is the best way to set yourself up for success.