Investment Team Voices Home Page

Convertible Securities Demonstrate Continued Resilience to Rising Rates

Convertible Team Perspectives by Eli Pars, CFA

With investors increasingly concerned about rising interest rates, we thought it would be a good opportunity to revisit one of our favorite convertible security charts. Regular readers may recognize the chart below, which compares the performance of U.S. convertibles with stocks and bonds during periods when the yield of the 10-year Treasury rose 100 basis points. We’ve updated it to include the most recent period of rising rates through 2016. Convertible securities again outperformed the broad bond market, thanks to their increased equity sensitivity and moderate duration (typically, the duration of the convertible market index is lower than that of the broad bond markets).

Returns in Rising Interest Rate Environments

Convertible Securities Have Outperformed Bonds During Recent Rising Interest Rate Period

Past performance is no guarantee of future results. *10-year Treasury yield. Rising rate environment periods from troughs to peak from October 1993 to December 2016. Performance shown is cumulative. Source: Morningstar.

We believe the remainder of 2017 is setting up to be a good year for convertible securities, which provide the opportunity for equity market upside participation with potential downside protection. As we have discussed in our recent outlook, we expect an increase in market volatility due to U.S. policy uncertainty, as well as central bank policies, populist sentiment and established geopolitical tensions. Still, economic data is improving overall, both in the U.S. and globally, which can provide a sustained tailwind for equities, and by extension, convertibles. Global issuance has also gotten off to a good start, with $6.2 billion coming to market in January, led by the U.S. at $3.3 billion. We believe economic growth should provide a healthy backdrop for issuance from here. Also, some of the proposed policies of the new U.S. administration could bolster issuance if enacted. For example, if interest deductibility is eliminated as part of tax code changes, companies would likely prefer issuing convertibles versus straight debt, due to the lower coupons typically offered by convertibles. Additionally, infrastructure spending could increase demand for capital.

    Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.

    Current performance may be lower or higher than the performance quoted. Indexes are unmanaged, do not reflect fees or expenses and are not available for direct investment. The BofA ML All U.S. Convertibles Index is a measure of the U.S. convertible market. The S&P 500 Index is a measure of the U.S. stock market. The Bloomberg Barclays U.S. Govt/Credit Index is comprised of long-term government and investment grade corporate debt securities. Most recent data as of 12/31/16. Rising rate environment periods from troughs to peak from October 1993 to December 2016.

    Convertible securities entail default risk and interest rate risk. Investments in high-yield securities include interest rate risk and credit risk.

    18551 0217O C