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marcus evans

September 04, 2013 16:16 ET

Assessing the Global Convertible Bonds Market

Interview With Luke Olsen, Head of Convertibles Research, EMEA & APAC, Barclays

LONDON, UNITED KINGDOM--(Marketwired - Sep 4, 2013) - In the last couple of years, the convertibles market has faced some challenges: fewer companies issuing convertible bonds, valuations were volatile, and multi-asset investors were not particularly interested in the asset class. However, the end of 2012 and beginning of 2013 saw an increase in issuance from corporates. Investor interest in the product has also grown significantly since the start of the year following a strong market performance. Consequently, demand for investment in convertible bonds is outweighing new supply. This situation could become more pronounced now that issuance has leveled off somewhat.

Luke Olsen, Head of Convertibles Research, EMEA & APAC, Barclays, recently spoke with marcus evans about key topics to be discussed at the upcoming 16th Annual Global Convertible Bonds Conference, September 30th - October 1st, 2013, in London. All responses represent the view of Mr. Olsen and not necessarily those of Barclays and its subsidiaries.

Is there still an appetite from investors for convertible bonds?

LO: Absolutely. This includes convertible long-only and hedge funds, as well as multi-asset investors. The enduring appeal of the convertible asset class is its positively convex exposure to equity markets -- more equity sensitivity on the upside and less on the downside. It can also be a stepping stone for fixed income-oriented investors to add equity risk at a time when bond yields have been very low and are now starting to rise. In addition, appetite is supported by net supply dynamics: the global convertible market has contracted in size in recent years as redemptions, conversions and repurchases of existing bonds exceeded new issuance, while many funds attracted inflows.

Please describe the current activity in the convertible bonds market. What impact has the macroeconomic environment had on the market?

LO: On the primary side, there are encouraging signs, with most regions seeing decent levels of issuance this year. That said, many convertible investors would welcome more. In Europe and Asia ex-Japan, new issuance has been running ahead of existing bond redemptions/conversions so far this year. Japan has seen a decent number of new convertible issues, but the pace of existing bond redemptions and conversions have been greater still.

On the macroeconomic side, some prevalent sectors in convertibles are also quite cyclical. This includes energy, basic resources, industrials, transport/autos, financial services and real estate. So unsurprisingly, we find significant correlation between the convertible market performance and macro trends. In an uncertain market environment, we believe the embedded convexity of the convertible asset class can help reduce portfolio volatility, adding to its appeal.

What geographical regions are particularly interesting? Do you think the boom in Japan is set to continue?

LO: Japan and the US convertibles have performed better than Europe and Asia ex-Japan so far this year, reflecting their positive stock market returns. However, all regions are currently in positive territory. In line with broader equity and credit markets, emerging markets convertibles have generally had a tougher time. Down the line, though, this may create an opportune entry point.

Japan's strong year-to-date convertible returns are linked to the broader market upturn. If that persists then Japanese convertibles should continue to shine. This year has seen a number of new issues from Japan, but not enough to offset the existing convertibles that were redeemed or converted. This dynamic has further lifted valuations, and markets would likely welcome further issuance.

What are the prospects for issuance like at the moment, and how will this develop going forward?

LO: Good, for several reasons. One is equity market levels. Companies are more likely to want to issue a convertible based off a higher share price. The market's rise over the past year has therefore helped. Another factor is interest rates. The potential coupon saving from issuing a convertible versus a straight bond increases as interest rates rise, all else equal. So again, the recent rise in rates is supportive. Secondary convertible valuations also matter. In times like these, with strong investor demand relative to supply, issuance is a more compelling value proposition. A further factor is availability of other funding sources. In Europe, for example, the secular loan to bond shift means some corporates are increasingly issuing bonds, both convertible and non-convertible. Lastly, given the preferences or mandates of some investors for investment grade convertibles, the opportunity for those issuers would seem all the greater.

Issuance could expand in scope, too. For example, the recent downturn in emerging markets has kept some primary markets quieter, but this could change in the future. Recent years have seen meaningful convertible issuance from South Africa, UAE, Hungary, and others. Also, sovereign-related exchangeables were quite popular in the past, and it might only take a few deals to re-ignite this.

What are the recent evolutions in the convertibles market?

LO: Convertibles are a well established, durable asset class, yet continually evolving. Recent trends include over-collateralised exchangeables and taps. In an over-collateralised exchangeable, the issuer pledges more shares than those underlying the bond, as security collateral for bondholders. This confers greater downside protection compared to an equivalent collateralized exchangeable where the ringfencing comprises only the exchange property. For the issuer, using part of the equity stake for over-collateralisation might make the transaction more appealing, and/or lower the coupon. There have been several taps to existing issues in recent months (historically, a relatively rare occurrence), helping to satiate strong investor demand. The familiarity with the company and bond structure is one potential advantage, while increasing the size of an existing issue could boost its liquidity.

Luke Olsen is a Managing Director and Head of Convertible Bonds Research, EMEA and Asia Pacific, and Head of Equity Derivatives Research, EMEA at Barclays, based in London. Dr. Olsen joined Barclays as an Equity Derivatives Quantitative Analyst in 1996 before joining the Convertible Bonds team in 1997. He has a BA in Mathematics and a PhD in Mathematical Modelling of Wound Healing from Corpus Christi College, University of Oxford.

The marcus evans 16th Annual Global Convertible Bonds Conference will take place in London, September 30 - October 1, 2013. For more information, visit the event website.

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