Although convertible bonds are a relatively small asset class, the choice of strategy and corresponding benchmark matters a lot when it comes to portfolio management. This has proven to be the case once again this year. Dispersion in returns between the individual convertible bond indices has been wider than ever. This is in particular, due to the benchmarks used by Fisch for its various strategies – the Refinitiv Global Vanilla, the Refinitiv Global Focus and the corresponding investment grade version, the Refinitiv Global Focus IG. Each of these have quite different compositions. The Vanilla index excludes mandatory CBs, but otherwise includes a broad universe. The Global Focus index comprises convex CBs, while the Global Focus IG is restricted to convex investment grade issues.
The drawdown after the Covid-19 outbreak last spring was 11.6% for Global Focus IG, 15.8% for Global Focus and 20.0% for Global Vanilla. However, during the subsequent equity market rally, Global Focus IG underperformed the broader index and as of 30 September there were substantial gaps in year-to-date (EUR-hedged) returns: Global Vanilla 16.0%, Global Focus 10.0% and Global Focus IG -1.0%. In comparison, the MSCI World equity index stood at 0% (see chart below).
Chart 1: YTD performance comparison of convertible bond indices (EUR hedged)
Source Bloomberg, MSCI, Refinitiv
There are three reasons for this above-average dispersion in returns.
First, there are the regional and sector differences in index composition (see tables 2 and 3). Here, the Global Focus IG has the highest European exposure (currently 62%) and a bias to “old economy” companies (such as industrials). Equity markets have also recovered less in Europe and in “old economy” sectors from the Covid-19 crisis. In contrast, Global Focus and, even more so, Global Vanilla carry far greater exposure to the US and to sectors seen as “Covid winners”, such as technology, communications and e-commerce. This has led to significantly better returns.
Table 2: Comparison of sector weights
Source Fisch Asset Management, Refinitiv
Table 3: Comparison of regional weights
Source Fisch Asset Management, Refinitiv
Second, we saw very heavy CB issuance this year (USD 132 billion up until September, compared to USD 109 billion for all of 2019). Many new CBs came onto the market especially in the second quarter. There were two main types of issuers: Traditional companies from the technology, pharma and biotech sectors on the one hand, while on the other, “pandemic victims” such as cruise ship operators, retailers and airlines.
Many in the first group were US growth companies, which took advantage of changing consumer behaviour and are financing future growth with convertible bonds. Most of them performed especially well after issuance. Unlike Global Vanilla and Global Focus, Global Focus IG has been poorly placed to tap into these trends.
Chart 4: Monthly global convertible bond issuance
Source Refinitiv, to September 2020
Third, Global Vanilla and Global Focus include far more names than Global Focus IG. Global Focus IG is therefore more susceptible to idiosyncratic risks, such as the one that arose from the Wirecard CB, which this year had a large negative impact of -1.63% on performance.
Table 5: Number of securities per index by sectors
Source Fisch Asset Management, Refinitiv
Conclusion and Outlook
Although the broader indices outperformed significantly this year – as they have for a long time, albeit with a greater associated risk – defensive, investment-grade-focused convertible bond strategies, in our view, still have a role to play in asset allocation. We doubt that year-to-date performance will be easy to sustain at this pace. Many European industrial companies are favourably priced by historical standards and will benefit more from the pandemic receding. Moreover, the lighter exposure of Global Focus IG to the US should offer greater protection from higher market volatility caused by the US elections and other US-related influences. During phases of market weakness, we expect Global Focus IG to outperform once again, which would continue to give it an attractive, defensive risk-return profile in the future. In addition to looking at returns from recent months, we therefore recommend when choosing particular convertible bond strategies, to undertake a comprehensive review of the characteristics of each index and to align your choice of benchmark with the corresponding individual investment goals.