Harnessing Convertible Opportunity: Bottom-Up Selection and Growth Themes Guide the Way

Jon Vacko, CFA, and Joe Wysocki, CFA

We believe:

• Our proprietary research and identification of secular themes position Calamos Convertible Fund advantageously.
• Continued emphasis on balanced convertibles aligns with CICVX’s pursuit of lower-volatility equity participation.
• Select opportunities exist in among yield alternatives, but we maintain a cautious stance on the most distressed credits.
• Recent issuance has offered investor-friendly characteristics, and a “higher-for-longer” interest rate environment may stoke increased convertible issuance.

The beginning of the third quarter of 2023 was characterized by a continuation of the equity rally of the first half of the year. Amid cooling inflation, stable geopolitical risks, and slowing but healthy economic and employment conditions, investors appeared more comfortable embracing a soft-landing narrative, However, the third quarter ended on a choppy note. Despite the Fed’s most recent pause in raising interest rates, market participants weighed the implications of the central bank’s intentions to keep rates “higher for longer.” Furthermore, investors also digested the potential impacts of the United Auto Workers strike, higher gas prices, and the prospect of a government shutdown; we would note that these have historically been more transitory risks to the economy.

Looking forward, we are cautiously optimistic but see multiple positives and negatives pushing and pulling the market. We believe additional Fed moves will remain data-dependent. This likely generates heightened uncertainty, but volatility has historically created opportunity in the convertible asset class. Any stabilization of the macro backdrop could turn what has been a narrow, larger-cap-driven S&P 500 leadership period into broader strength, which we believe would benefit convertibles, given many issuers lean toward more mid-cap, growth-oriented companies.

Within Calamos Convertible Fund (CICVX), our overall focus remains on bottom-up company selection and actively managing risk/reward tradeoffs. Convertible securities combine attributes of stocks and bonds and vary in their levels of equity and fixed income sensitivity. Within CICVX, we maintain our preference for balanced convertible structures that provide a favorable asymmetric payoff profile by offering potentially attractive levels of upside equity participation with less exposure to downside moves. We have also found opportunities among convertibles with higher levels of fixed income sensitivity; these can benefit from spread compression while offering attractive yields and good structural risk mitigation from potential equity market weakness. We remain selective in regard to the lowest quality credits, instead preferring companies with solvent business models, improving financial metrics, and balance sheet liquidity.

Technology, health care and consumer discretionary remain CICVX’s largest sector allocations. Relying on our proprietary bottom-up company analysis, we favor companies with improving margins and free cash flow, accelerating returns on invested capital, attractive valuations, and the ability to execute well despite macro uncertainties. We also focus on identifying innovative companies positioned to benefit from enduring secular themes. Secular trends, such as cybersecurity and electric vehicle adoption, serve as a tailwind in uncertain periods and help us identify firms with valuations that are most likely to be rewarded over time. Other secular themes represented in the fund include automation, productivity enhancement, and artificial intelligence. Companies exposed to these themes are advantageously positioned as businesses seek solutions to higher labor, manufacturing, and interest costs in the current economic environment.

Convertible new issuance accelerated into September and is on track to match historical long-term trends for the year. This year’s issuance has been characterized by investor-friendly higher coupons and lower conversion premiums. We’ve also been encouraged to see more investment-grade companies issue convertibles. We remain optimistic about issuance prospects and believe the pace will continue to be strong as companies increasingly recognize the lower-borrowing-cost benefits of issuing convertibles in lieu of traditional bonds. The combination of a sizable amount of debt maturing in 2025 across bond markets and the Fed’s higher-for-longer interest rate stance could serve as an accelerant for near-term issuance.