oaktree insights august 2020
the case for convertible bonds
333 s. grand ave 28th floor, los angeles, ca 90071 | (213) 830-6300 | www.oaktreecapital.com the case for convertible bonds
key points
• Global convertible issuance has surged in the wake of the COVID-19 outbreak. The $92 billion of convertible securities issued year-to-date (as of June 30, 2020) is the highest first-half total on record. While much of this issuance has come from U.S.-based companies, sector and “Convertibles are particularly market capitalization representations have been broad. versatile securities. Managed • The global convertibles market today includes over $380 billion of securities from 750 companies.1 U.S. companies represent according to Oaktree’s approximately two-thirds of the convertible bond universe, with the approach, they tend to share rest of the market represented by issuers in Europe (16%), Japan (5%) in most of the gains when the and Asia ex-Japan (11%; mostly China). Convertible issuers include high-growth technology and pharmaceutical corporations, as well as stock market does well and established industrial conglomerates. provide a measure of protection • Convertible securities offer investors the potential for equity-like when the stock market does appreciation while providing the downside risk protection of a fixed income instrument. Oaktree believes the defensive nature of the asset poorly. This makes them a class, coupled with the potential for future upside participation, makes good way to invest when the investing in convertibles a compelling opportunity in today’s volatile outlook is uncertain . . . and and challenging environment. I think the outlook is always • Investors view convertible bonds as debt instruments with an attached equity option. While there are many approaches to investing in uncertain.” convertible bonds, we like to refer to the asset class as “equities with – Howard Marks training wheels.” Historical analysis of convertibles shows the asset class may add value to diversified portfolios. • Convertible securities have also been one of the strongest performing asset classes in 2020, with the Refinitiv Convertible Global Focus (USD) Index gaining 5.1% year-to-date (as of June 30, 2020), versus the FTSE All-World equity and FTSE High-Yield Market indices losing 5.2% and 4.8% during the same period, respectively.
- 1 - current market dynamics upside participation should equity In light of the economic stress caused markets rise. Indeed, while many by COVID-19, many cash-strapped companies have suspended equity divi- issuers in need of liquidity have sought dend payments amid the operational out cheaper ways to borrow money. and financial disruption wrought by The solution, in many cases, has been COVID-19, convertible bonds can convertible bonds. Global new issuance offer equity investors current income in of convertibles has surged in 2020, with the form of coupon payments. Further- close to $92 billion coming to market more, cheaper pricing among the influx A business communication software year-to-date (through June 30, 2020), of these new deals has provided attrac- platform issued about $860 million higher than any first-half total on record. tive entry points for investors. worth of convertible bonds in the Much of this year’s total has come from second quarter to further finance its companies in the travel, leisure and growth. This five-year convertible retail industries, which have been hard potential benefits of bond seemed well-positioned given hit by the impact of the pandemic. convertible bonds within its senior unsecured ranking and a diversified portfolio its long-dated call option on the For today’s struggling companies, part of company’s equity. The equity and the appeal for issuing convertible bonds Simple analysis of returns over time convertible bond were up approxi- is lower cost: convertibles typically pay shows that a strategic, long-term allo- mately 30% and 20%, respectively, a lower coupon than traditional fixed cation to convertibles raises efficient from early April through June, income instruments due to the value of frontiers. Compared with a portfolio already providing convertible inves- the attached equity option. Furthermore, consisting of only stocks and bonds, tors an attractive return through the convertible bonds often afford issuers a the portfolio with convertibles shows market’s recent volatility. path to equity issuance at a premium to similar returns but with a much lower current market prices. These characteris- standard deviation, as shown in Figure A leading telemedicine company, tics have opened the convertibles market 1 (see next page). which provides a network of on-de- to companies that may not otherwise mand remote doctors available have turned to such deals. Below are some reasons investors may 24/7 for consultations, raised $1 add convertibles to their portfolios: billion in May to refinance existing The convertibles market has been debt and add to its robust balance tapped for opportunistic reasons as • Fixed income investors: sheet for future growth. The seven- well, primarily by companies in high- Convertibles may 1) enhance year convertible was issued with a growth sectors such as technology traditional fixed income returns 1.25% coupon and 35% conversion and healthcare. These are two of the through exposure to equity- premium. In recent months this best-performing sectors in the equity driven price increases; 2) reduce company has witnessed significantly market this year and are widely believed the impact of rising interest higher levels of app downloads and to be poised to thrive in the current rates, due to more potential a broadening of its health plan rela- volatile market environment and, in return coming through the tionships. Its stock and convertible some cases, to provide much-needed convertible’s equity option; or were both up approximately 10% solutions to the ongoing global health 3) increase alpha with their from mid-May through June. crisis. Examples of recent opportunistic asymmetric return profiles (i.e., issuers include a collaboration software more upside potential than company and a remote healthcare downside risk). provider (see Sidebar). • Equity investors: Convertibles may 1) provide current income In line with the surge in new issuance, and protection against severe performance of convertibles has been market declines; 2) add notably strong this year, with the asset diversification benefits; or 3) create class gaining 5.1% through June while “equities with stabilizers” (i.e., global equities have declined 5.2%.2 reducing downside risk without Convertibles have attracted investors forgoing all upside potential). who want to maintain the downside support of a fixed income instrument in an uncertain economic environment while also keeping the potential for - 2 - Figure 1:Diversification Benefit of Including Convertible Bonds in a Portfolio 3, 4
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