Convertible bonds: From niche to mainstream
William Weichhart | Senior Product Analyst | FIS’ Capital Markets, Convertible Bonds Services
February 19, 2021
The hybrid performance characteristics of convertibles, combining elements of both fixed income and equities, results in counter-cyclical performance for investors and attractiveness for issuers. Convertibles’ outperformance in 2020 is exemplified by FIS® Convertible Bonds Services’ proprietary long-only U.S. convertible index which returned 48% for the year, as compared to 16% for the S&P500.
Furthermore, the hybrid convexity of their returns was perfectly illustrated at the market lows in March 2020, when the FIS Convertible Bonds Service’ US convertibles index was down only 20% as compared to 30% for the S&P 500. Global issuance of convertibles surged in 2020 to close on USD $200B, dwarfing all previous years, even pre-financial crisis.
With uncertainty and volatility set to continue in 2021, it is unsurprising that a growing number of hedge funds are looking to increase exposure to convertibles. Given their inherent complexity and the growing universe, how can funds quickly scale up their exposure while maintaining robust risk management?
- Robust analytics Convertibles are a highly complex asset class with a potentially large number of moving parts and array of bells and whistles. Hedge funds require robust and comprehensive analytics that inspire confidence in a highly complex and esoteric asset class.
- High-quality data With a burgeoning, complex and heterogeneous universe of instruments, data integrity is vital. Complex terms and conditions require accurate and timely modelling at new issue as well as pro-active management throughout the instrument lifecycle.
- Flexible deployment From portfolio grid views and complex multi-factor scenario analysis to trading workflow and market monitoring, compliance checks and regulatory reporting; multifarious roles within organizations – and indeed across the wider convertibles’ marketplace – have a complex range of distinct requirements.
Having the ability to deploy the same high-quality analytics and data through a flexible and extensible set of solutions, whether on-premise or in the cloud, ensures a unified view can be achieved both across organizations and more widely. That can also to help establish market consensus.
- Extensible asset coverage SPACs (special purpose acquisition companies) have also seen explosive growth over the last year and are currently the predominant means of taking firms public in the U.S. Flexible convertible analytics can help model the embedded warrants, which typically include an issuer “soft call” option at a specific equity trigger level, which is similar to that found in many convertibles. With a rapidly expanding universe, quality assured data is again crucial.
Banks’ Capital Contingent Convertible bonds, variously referred to as AT1s, CoCos or CapCoCos, saw rapid growth in the post financial crisis regulatory environment. While the conversion element is upon a downside trigger event, these are an example of another asset class that can be modelled using flexible convertible bond analytics.
Flexible convertible bond analytics and deployment options, combined with proactive data management, are the keys to hedge fund agility in convertible bonds and a multitude of other equity linked asset classes.