Global Convertibles

Lazard Global Convertibles

Convertible bonds have both equity and bond attributes. Their differentiated Key Characteristics investment profile can introduce new • Attractive Investment Profile Participation in equity upside possibilities for investors. with historically lower volatility in down markets Convertible bonds are a form of financing arrangement that allows inves- • Skilled Security Selection tors to begin as a lender and potentially end as a shareholder due to their Returns driven by experienced embedded equity option. They have started to earn dedicated allocations in fundamental and technical institutional portfolios and, as such, we believe these securities are begin- analysis ning to be viewed as a distinct asset class. • High-Conviction Active Management The risk-return profile of convertible bonds stands out versus other asset The majority of the strategy’s classes. Their fluid identity is their strength, as they generally exhibit portfolio is held outside the bond-like characteristics in declining equity markets, and equity-like benchmark characteristics in rising equity markets. It follows that the bond should be analyzed in the context of the market environment to determine its invest- ment profile at a particular point in time and relevance to an investor’s objective. This analysis requires skill and experience, as it calls for tech- nical, fundamental, and tactical analysis. Done well, the potential benefits to investors can be consistent and meaningful.

The global universe of convertible bonds currently consists of about 1,000 securities valued at $400 billion to $500 billion, with issuance focused on the United States and Europe. We believe active management is instru- mental to better determine which bonds have strong fundamentals and attractive return prospects. Bottom-up fundamental analysis in particular can help investors identify potential opportunities beyond benchmarks, which currently capture less than the universe.

Snapshot

Inception Investment Expected Strategy Date Benchmark Universe Tracking Errora Lazard Global Convertibles January 2008 Thomson Reuters Convertible Approx. 1,000 convertible 2.5% to 3.5% Global Focus Index bonds

No. of Holdings/ Equity Exposure/ Market Expected Target Max. Position Size Equity Holdings Capitalization Annual Turnover Returnsa, b Approx. 60–75 securities/ Approx. 20%–65%/ >US$100 million <40% 6% Up to 5% of NAV 10% maximum exposure to stocks from conversions

a Annualized for the 10 years ending 31 December 2019. b Target Returns do not represent a promise or guarantee of future returns and are subject to change.

SP29563 2

Convertible Bonds and Convexity A convertible bond’s interest payments and seniority in the capital structure may also be particularly relevant for investors with liability Convertible bonds simultaneously inhabit two worlds, combining constraints. (More than 80% of all convertible bonds are senior unse- features of both equity and fixed income securities. The resulting price cured debt, which is second only to senior secured debt.) Meanwhile, convexity is the defining characteristic of a convertible bond—which their equity conversion option offers growth potential beyond that of a is most valuable when it is strongly convex. In this ideal state, the conventional bond. bond has a perfectly balanced dual identity and should be able to track rising equity markets in the long run as its underlying equity exposure “Our goal is to construct a increases, and defend better than stocks when equity markets decline and its underlying equity exposure decreases (and its fixed income portfolio that takes advantage identity begins to dominate). Asset class returns and volatility annualized over the past five and of convertible bonds’ attractive 10 years support this theory of convexity. Over both periods, global convertible bonds participated in the equity advance with considerably return and volatility profile …” less volatility. Yet while they exhibited more volatility than bonds have over both periods, they soundly outgained bonds (Exhibit 1). Our Philosophy Our goal is to construct a portfolio that takes advantage of convert- Risk considerations are foundational to our investment approach and ible bonds’ attractive return and volatility profile by seeking out we seek returns with this in mind. We believe that bottom-up, funda- bonds with strong convexity. We believe that deep analytical skill and mental analysis is crucial to identifying what we believe are the most experience are key to this endeavor, and we spare no effort in our fun- attractive convertible bonds. We are firmly convinced that there is no damental and technical analysis, especially considering that convexity substitute for it and our fundamental research frequently leads us to is not strongly present in all convertible bonds at all times. opportunities outside the benchmark.

Exhibit 1 Convertible Bonds Could Help Optimize Risk Budgets

5 Years, Annualized 10 Years, Annualized

(%) (%) 8.4 8.8 9 9 Convertible Bonds Thomson Reuters 6.1 Global Convertible 5.1 6 6 Bond Index

2.5 3 2.3 3 Equity MSCI ACWI Net Total Return Index 0 0 Performance Performance Fixed Income Bloomberg Barclays Global Aggregate (%) (%) Total Return Index – Value Unhedged 15 15 13.2 11.8

10 10 8.6 7.4

4.5 4.6 5 5

0 0 Volatility Volatility

As of 31 December 2019 The performance quoted represents past performance. Past performance is not a reliable indicator of future results. The indices are unmanaged and have no fees. One cannot invest directly in an index. Data measured in US dollars. Source: Lazard, Bloomberg, MSCI, Thomson Reuters 3

Investment Process Lazard recognizes that a company’s environmental, social, and corpo- rate governance (ESG) practices, whether good or bad, can affect its Our investment process is driven by bottom-up analysis, which financial performance. We integrate third-party ESG data and ratings includes a rigorous quantitative and qualitative review of each to better assess the degree to which ESG considerations are reflected in convertible bond (Exhibit 2). We incorporate top-down analysis of a given company’s policies and practices. macroeconomic scenarios to guide tactical decisions in the portfolio. We adhere to a disciplined, sustainable process, developing an invest- Step 1 ment thesis for each convertible bond and reviewing it on a quarterly Screening the Eligible Universe basis. At the conclusion of this step, the investment universe is nar- rowed to approximately 150 to 200 securities. We evaluate the global universe of approximately 1,000 convert- ible bonds, screening candidates based on factors such as liquidity, Step 3 maturity, credit rating, base currency, and the availability of audited Portfolio Construction financial data. This typically reduces the investment pool by half. To arrive at a concentrated portfolio of approximately 60 to 75 con- Step 2 vertible bonds, we consider convexity, asymmetry, legal structure, and Fundamental and Credit Analysis sensitivity to credit risk among other investment characteristics. Once we establish an understanding of a bond’s equity or credit prospects, We evaluate the investment profiles of the remaining 400 to 450 we are better positioned to set our target valuation. securities, seeking to determine whether they exhibit more equity- like features, bond-like features, or some combination of the two. The portfolio’s global exposure is predominantly the result of our We analyze each bond from a credit, underlying equity, and market bottom-up process, with some tactical input from our macroeconomic perspective, taking into consideration Lazard’s macroeconomic expectations. We may calibrate the portfolio’s volatility profile or expertise. adjust its exposure to equities, rates, or currencies through limited use of futures or options.

Exhibit 2 Bottom-Up Portfolio Construction

Portfolio Construction

Fundamental and Target Portfolio Credit Analysis Factors in Lazard’s macroeconomic analysis Determine the Tactical allocation nature of the CB Convexity Equity Equity and interest rate Mixed exposure in the major Bonds geographical areas Convertible Bond Screening the Exposure to credit risk Universe Eligible Universe Analysis tailored to Sensitivity to volatility the nature of the CB Currency exposure Liquidity Credit analysis Rating Analysis of the Portfolio Calibration Maturity underlying equity Exposures or hedging (via a Available currencies Market analysis futures or options) Frequency of publication of Investment thesis Equities: audited results for each CB Index and underlying Rates: Index Currencies ESG Volatility Analysis

Concentrated Portfolio

900–1,000 CBs 400–450 CBs 150–200 CBs 60–75 CBs

a Futures on equity indices (e.g., Euro Stoxx, S&P), rates (e.g., Bund, Bobl, US), currencies; and options on indices/underlying assets (exposure, hedging) and volatility. Lazard Global Convertibles

Portfolio Management Team

Arnaud Brillois, CFA Emmanuel Naar Andrew Raab Emmanuel Cuche Managing Director Vice President Vice President Associate Portfolio Manager/Analyst Portfolio Manager/Analyst Portfolio Manager/Analyst Portfolio Manager/Analyst

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