Convertible Securities Provide Well-Priced Access to Growth
John P. Calamos, Sr.
September 21, 2017
Convertible securities offer a wide range of potential benefits, thanks to their combination of stock and bond attributes. They have been less vulnerable to rising interest rates than non-convertible bonds due to their equity attributes, while their fixed income attributes can provide potential downside protection during periods of short- term stock market volatility. (For more on how convertibles work, see our guide, “Convertible Securities: Structures, Valuation, Market Environment and Asset Allocation”.)
Convertible securities can also provide a way to access growth opportunities at attractive valuations. As the chart below shows, the average valuation of the U.S. convertible universe is currently below its long-term mean and toward the bottom of what we consider to be the “fair valuation” band.
Attractive Valuations in the U.S. Convertible Market
Valuations are not an indication of how a fund will perform. Past performance is no guarantee of future results. Source: BofA Merrill Lynch.
However, it’s important to remember:
The convertible universe is diverse. There is a good deal of variation among the valuations of individual convertibles—some are overvalued and some are undervalued. In addition to the differences in valuations, convertibles can also vary in their degree of equity and fixed income sensitivity. The characteristics of an individual convertible can change over time, as can the attributes of the convertible universe as a whole. Also, there are often meaningful valuation differences among regions. For example, over the past few years, European investment grade convertibles have had richer valuations than investment grade convertibles in the U.S. and elsewhere.
There can still be opportunities in convertibles when the “average” valuation is higher. As discussed in our white paper “The Case for Strategic Convertible Allocations,” our teams “are not looking to buy the asset class as a whole, but rather, to construct portfolios of securities most likely to deliver the specific risk/return profiles we seek.”
Active management is key. As we often say, it is not simply the inclusion of a convertible that makes a strategy work, what matters is how convertibles are managed to achieve a specific outcome. And, in an environment of economic growth and slowly rising interest rates, I believe actively managed convertible allocations can address a range of needs—from lower volatility equity participation to providing income that’s less vulnerable to duration risk.
In the graph above, convertibles are represented by the BofA Merrill Lynch All U.S. Convertibles Index, a measure of the U.S. convertible market. Indexes are unmanaged, do not entail fees or expenses and are not available for direct investment.