Appetite for Convertible Bonds Grows - Financial Times - March 2011

Advent in the Press

Big investors looking for protection against rises in interest rates have stoked demand for convertible bonds, with global issuance rising sharply and putting the market on course for its best year since 2008.

Companies last week sold $9.4bn of convertible bonds, debt which can be exchanged for equity at a pre-agreed price trigger, according to data from Dealogic.

These figures marked the strongest week of issuance since May 2008 and included the year’s two largest single issues, from MetLife, the US insurer, and Sinopec, the Chinese oil company.

This week, Cemex, Mexico’s cement group, said it would sell $1.2bn in convertible notes, which would be the third largest sale of the year.

So far this year, companies have sold $18.7bn of convertible bonds, the best pace since 2008.

Convertible bond issuance shrank over the past three years, as companies were able to sell more conventional debt, which does not carry a risk of equity dilution, at historically low rates. Yields on global corporate debt are at an average premium over benchmark US Treasuries of 1.51 per cent, versus a premium of 6.2 per cent for convertibles, according to Barclays Capital indices. But as yields on US and other government bonds have risen since late 2010, in part because of economic recovery hopes, convertibles have become more attractive.

“As rates increase, convertibles will become even more compelling to issuers. The companies looking at this market now are skating to where the puck is going,” said Paul Donahue, co-head of US equity capital markets at Morgan Stanley.

Traditional fixed income investors, including Pimco, have also been eager to buy convertibles recently.

Loomis Sayles, a fixed income-focused fund manager with $151bn in assets, has also been a buyer of convertibles.

“We are seeing crossover interest from credit and fixed income accounts looking for the equity participation component of convertibles,” said David Puritz, head of US convertibles sales and trading at Nomura in New York.

Mr Puritz said the investor base of convertibles had shifted from about 80 per cent hedge funds to a nearly even split with mainstream investing institutions.

“Trading volumes have been aggressive in January and February as new funds come into the market seeking convertibles,” he said.

So far in 2011, convertibles’ returns have lagged behind those of equities slightly, with prices up 4.4 per cent, according to the Bank of America Merrill Lynch US convertibles index, versus a 5.1 per cent rise in the S&P 500 index.

“In a short time frame, convertibles lag on the upside due to the conversion premium [the cost of exchanging debt for equity],” said Tracy Maitland, president of Advent Capital Management, which manages $6bn in assets. “But over a longer period, they outperform because of the yield. They also tend to lose less on the downside.” Last year, convertibles saw stronger returns than all asset classes except small-cap stocks, rising 15.5 per cent, according to the BofAML index.