Opportunities in convertibles after sell-off

Following the 2008 turmoil, convertible bonds are currently offering very compelling opportunities for investors, according to Anja Eijking, manager of the F&C Global Convertible Bond Fund.

During 2008, hedge funds and banks sold off their holdings in corporate bonds, resulting in market prices falling to record lows. The convertibles market, as a result, has been repriced in an unprecedented manner. Against the background of huge selling pressure during September and October by predominantly convertible arbitrage funds, convertibles prices fell further than equity markets.

"Convertibles did not offer the downside protection one may expect based on their bond component", explained Eijking. "However, the disappointing absolute performance of the asset class has its benefits as it now offers very attractive investment opportunities with limited risk and attractive upside potential in the wake of the sell-off."

Asian convertibles have also been strongly repriced. "We have bought several interesting convertibles during the sell-off", commented Alan van der Kamp, Portfolio Marketing Manager at F&C.

One example is Cherating Capital, converting into equity shares of the Malaysian toll road company Plus Expressways. Although this convertible is not officially rated by the rating agencies, it is being guaranteed by Khazanah Nasional, the investment entity of the S&P A-rated Malaysian government. On the back of the market sell-off, this convertible lost 30% of its value in the two months ending October 2008, while the underlying shares fell by just 6%. The convertible was added to the portfolio in October at a price of 74.

"The yield-to-maturity of this convertible was approximately 14.7%, which is very high in comparison with Malaysian government bonds", Eijking added. These bonds were trading at a credit spread of 165 basis points. Additionally, the conversion premium was only 10%; the convertible was expected to participate in the underlying shares increase to a large extent.

"We like this company as it has a very stable profile", said Eijking. "Since October the convertible's price has appreciated by approximately 30%. The convertible is currently trading at a 7% yield-to-maturity, still relatively high in comparison with Malaysian government paper (2.8% yield-to-maturity). Given the conversion premium of 37%, the risk/reward profile of this convertible remains attractive."

F&C's convertibles team's strategy remains focused on adding convertibles to the portfolio with a similar attractive total return potential and limited risk. It also seeks to reduce exposure to low yielding convertibles that are trading near redemption price and with high conversion premiums. "The total return potential of our convertibles is very attractive with a yield-to-maturity of over 8% and equity market participation of ca. 35%", Alan van der Kamp concluded.