Convertible Market Trends: Looking Under the Hood

When John P. Calamos, Sr., Calamos Investments’ Founder and Global Chief Investment Officer, first began investing in convertible securities in the 1970s, they were essentially an alternative asset class with potential benefits that weren’t widely recognized. Fast-forward five decades, and there’s a much greater understanding of the unique opportunities of these hybrid securities, now an asset class totaling $374 billion globally as of the end of August. However, there’s still far less coverage of convertibles compared to many major asset classes.

In this post, we’ll explore some of the key trends in the convertible market.

A well-diversified global market. Today’s convertible market also offers a breadth of opportunities across market caps, geographies, credit qualities, and levels of structural risk. “Historically, US growth-oriented small and mid-sized companies have been especially well represented among convertible issuers, but we’re also seeing increased representation from larger bellwether, investment grade issuers, which is an exciting trend,” said Joe Wysocki, Senior Vice President and Senior Co-Portfolio Manager.

Another key trend is the increased presence of global issuers in the convertible market. “This year, some of the largest issues have come from tech-oriented companies in emerging Asia, giving us new opportunities to access growth potential with potentially less downside,” noted Eli Pars, Co-Chief Investment Officer and Senior Co-Portfolio Manager.

Perspectives on new issuance. Similar to other areas of the capital markets, convertible issuance trends ebb and flow due to a range of factors, including the economic backdrop, companies’ desire to seek growth capital, and interest rates. For example, issuance was particularly strong in 2020 and 2021. “Convertible markets are typically among the first to open after a credit crunch, like the one we saw when the Covid pandemic hit. We wouldn’t expect to maintain those levels over the long term,” said Pars.

So far in 2024, issuance has remained healthy, totaling $73 billion through August. The Calamos team expects issuance to remain brisk for a variety of reasons. “Convertible issuance is about capital market access, which is tied to economic growth,” explained Calamos, “In other words, companies issue convertibles to fund expansion, and that’s likely to continue in the current economic environment.”

Additionally, in exchange for the opportunity to convert to shares of common stock, companies can issue convertibles with lower coupons than comparable non-traditional debt. “Even in the wake of the Fed’s rate cuts, the convertible structure continues to be an attractive choice for companies seeking to lower their borrowing costs,” said Jon Vacko, Senior Vice President and Senior Co-Portfolio Manager.

Global Convertible Issuance ($bn)

As of August 31, 2024. Source: BofA Global Research.

Maturing convertibles, new opportunities. Over recent years, most convertibles have been issued with five-year maturities, which means there’s a maturity wall on the horizon for securities issued in 2020 and 2021. “We expect many of these issuers will replace their maturing securities with new ones, and we are seeing high-yield issuers refinancing with convertibles as well,” said Wysocki.

Characteristics of the New Convertible Issuance Market Versus the Broad US and Global Convertible Markets

• Higher yields. The yields of new convertibles are higher than the existing market. The average yield of newly issued convertibles was 3.07%, as measured by the ICE BofA New Issue Convertible Index. In contrast, the average yield of the US convertible market was 2.08%, as measured by the ICE BofA All US Convertibles Index.

  US Convertible Market Yields

  

  Past performance is no guarantee of future results. Source: BofA Global Research.

• Total return structures dominate. Convertible securities vary in their levels of equity and fixed income sensitivity, with these levels changing over time for both individual convertibles and the convertible universe as a whole. Within the US new issuance index, convertibles with balance structures currently represent the lion’s share of securities, followed by yield alternatives, standing in contrast to the broader US and global markets.

  Convertible Market by Structure: Yield, Total Return and Equity Alternatives

  

  Source: BofA Global Research. Data as of August 31, 2024.

Calamos: Investing in Convertibles, not the Convertible Market

Although a steady stream of issuance is encouraging, our teams are quick to note that issuance is not the primary determinant of the opportunity of the asset class. “We’re not investing in the convertible market,” said Calamos, “Our teams are investing in individual securities. Not every new issue will give us an attractive risk/reward trade-off.”

Calamos continued, “It’s also important to remember that convertibles can be used to pursue different goals. A convertible with balanced levels of equity and fixed income sensitivity will be a good choice for a lower-volatility equity strategy, but other investment goals might call for a security with higher equity sensitivity or higher bond sensitivity. Convertibles need to be actively managed.”

Wysocki expanded, “Our team has invested through many different convertible market environments. Just because the overall market has certain characteristics doesn’t mean that those are the characteristics of every security in the market. There are great opportunities even if issuance isn’t at sky-high levels. That’s where experience and research make the difference and where we believe we add value.”