Positive outlook for convertibles as valuations remain attractive

Over the last couple of years there has seen a surge in popularity of convertible bonds with more investors attracted to the potential capital gains and defensive nature of the asset class.

Issuance of convertibles hit record numbers in 2007, representing some $200bn. However, during the last months the asset class has taken a severe blow by liquidations of predominantly convertible arbitrage funds, having lead to unprecedented cheap valuations with many convertibles trading below their bond values and offering cheap options to convert to shares.

As any other asset class, convertible bonds have felt the impact of the current rising credit spreads and declining share prices. However, F&C's convertibles investment style has proven successful through multiple cycles and the fundamentals of its investment strategy have not been changed since the firm started managing these assets 10 years ago. F&C's focus on credit quality, diversification across regions, sectors and issuers, avoidance of large single issue bets, and the defensive stance towards long-term convertibles with risky structures mainly issued by US financial institutions, has proven beneficial during the current financial markets' crisis.

Historically the long term risk/rewards profile of convertibles has been superior to that of equities and bonds, with convertibles outperforming both asset classes on an annualised basis in a risk reduced manner. The reason for this is that convertible bonds offer investors the opportunity to participate and benefit from the unlimited upside potential of share price appreciation whilst the downside risk is limited to the bond value of the convertible bond.

"Convertibles as an asset class have cheapened substantially as a result of the credit crisis and the unfavourable market technical developments", commented Anja Eijking, Head of Convertibles at F&C Investments and manager of the F&C Global Convertible Bond Fund. "We believe convertibles are currently undervalued and offer attractive investment opportunities as part of any asset allocation process. For the 12 months ahead we are positive on expected returns", so Anja Eijking. "Convertibles offer some 10% yield to maturity and in addition circa 40% equity participation in recovering equity markets. We think that financial markets do not fully price in the positive developments such as the vast support packages for financial institutions, lowered inflations expectations, fiscal and economic stimulus packages still to be spent and an expected stabilisation of the US housing market in the second half of 2009. With this in mind and following the extreme sell-off in the convertible markets, convertibles provide an attractive investment opportunity to participate in recovering capital markets in a risk reduced manner."