Like other equity-related investments, convertible bond funds have not performed well this year, particularly those with Asian underlyings. But they are starting to attract flows again after a torrid few months, says Skander Chabbi, head of convertible bonds at BNP Paribas Asset Management.
Global CB funds have lost around 6% in the year to early December, and Asia CB products have fared worse, falling between 9% and 12% in the same period.
Still, such returns are in line with expectations, said Paris-based Chabbi during a trip to Asia this week. In fact, CB funds have held up significantly better than they did after the Lehman Brothers collapse, he notes, when there was a great deal more panic selling.
That said, Asia CB funds don’t tend to be as big as their global peers, because investors such as private banks are big direct buyers of CBs rather than pooled products, Chabbi tells AsianInvestor. In terms of global CB funds, there were inflows until March, then a “steady trickle outwards” until September, after which money has started to return.
BNP Paribas Investment Partners has €1.7 billion ($2.2 billion) in AUM in its global CB strategies and €236 million in its Asian CB products, with the latter managed by a Hong Kong-based team of one portfolio manager and two analysts.
The performance of CBs in Europe and Asia has largely been down to the impact of widening credit spreads, says Chabbi, whereas that of CBs in the US is more the result of equity returns.
Equity sensitivity – that is, CB price change related to the move of the underlying stock – has been relatively low in Asia and Europe, at 25–30%. As a result, says Chabbi, very few bonds will be converted into equity, meaning most are acting like debt instruments and providing a burden for issuers.
Moreover, a relatively quiet pipeline of issues in the region and globally so far in 2011 may be about to start flowing again, given how tough it is to raise money via traditional bonds or loans.
“From a new-issuance perspective, things have been a bit disappointing this year,” says Chabbi. “Market skittishness and volatility have closed down a lot of the new issuance windows.”
But he is seeing a “slight increase in interest” from issuers, because the high-yield and credit markets are seizing up and getting costlier to tap. For example, Agile Property Holdings in early April sold $500 million in CBs with a 4% coupon, as compared to paying coupons of 8.5%-plus on HY issues in 2010.
Another plus point for CBs is that interest rates may rise, he says, creating a better value proposition for CBs than straight debt. Moreover, an important factor for pricing CBs is implied equity volatility – and since it is relatively low now, at 10–15% on average in Asia, it is a good time to buy these instruments, says Chabbi.
On the downside, however, if credit spreads continue to widen and equity prices remain weak, that would be bad for the CB market.
From an investor’s point of view, CBs are short-tenor (three- to five-year) bonds that provide an opportunity to buy debt and also to participate in more than half a stock’s equity returns with less than half the volatility, on average.
The disadvantage from an issuer’s point of view is that these instruments dilute equity for existing shareholders, says Chabbi, “but it's a decent trade-off”.
Other related structures – though not true CBs, says Chabbi – are exchangeable bonds (EBs), for which the market in Asia is starting to open up.
A recent issue was that of Temasek Holdings raising S$500 million ($390 million) worth of bonds exchangeable into Hong Kong-listed Li & Fung in early December. This came just two months after the Singapore investment firm sold S$800 million of bonds exchangeable into Standard Chartered. There was strong demand for both.
The EB structure has been more common in the past in Europe, but highly rated issuers in Asia are starting to recognise that this is a good way to sell forward a stake at a premium, says Chabbi. Some investors don’t mind buying expensive structures in exchange for good credit structures, he adds, particularly in the current markets.