Your experts for convertible bonds

Convertible bonds (also known as convertible loan note) are a special form of corporate bond: As with a conventional corporate bond, the issuing company pays regular interest (coupon) to the holder of the convertible bond over a fixed period of time. The special feature, however, is that convertible bonds have a conversion right that allows the holder to convert the bonds into shares of the company within a certain period of time at a fixed price and under defined conditions.

The conversion right is usually voluntary. If the investor does not exercise it, he continues to receive the predetermined interest and, at the end of the term, the nominal value of the bond. However, once the investor has decided in favour of the conversion, it can no longer be reversed: This means that the shares cannot be exchanged back into bonds. The exchange can be worthwhile for the investor if the current share price is higher than the agreed conversion price. However, unlike for the bonds, they no longer receive fixed interest payments for the shares. Instead, a dividend payment is possible, although the amount may fluctuate.

Due to the complex investment conditions and the high minimum denominations – sometimes as much as 250.000 euros – convertible bond investment funds are more suitable for private investors than investments in individual convertible bonds.

This is how convertible bond prices behave

Influence of the share price: The closer the company's share price approaches the price at which conversion would be advantageous, the more the price of the bond behaves like the share price. If the share price exceeds the conversion price, the convertible bond increasingly behaves like the share. The share sensitivity – known as the delta in technical jargon – is then typically between 0.50 and 1.00.

Influence of the bond price: In contrast, the price of the convertible bond is almost identical to that of a traditional bond after the share price has fallen far below the conversion price and conversion has become uninteresting for the investor.

Special case of mandatory convertible bonds

In the case of mandatory convertible bonds, the conversion right is not voluntary. They are automatically converted into equities at the end of their maturities. Typically, two conversion prices are defined at the time of issue: one below and one above the current share price. Share fluctuations between these two conversion prices are equalised by adjusting the conversion ratio. If the share price falls, the investor receives more equities on conversion and vice versa. There is no compensation for fluctuations outside these two conversion prices and the convertible bond behaves in a similar way to the equities.

The risk: As the investor does not have the option of returning the mandatory convertible bond at par value, there is no protection against losses.

However, mandatory convertible bonds play a subordinate role and currently account for less than 5% of the total convertible bond universe.

Special case of CoCo bonds

CoCo bond is the abbreviation for contingent convertible bond. With this form of convertible bond, as with mandatory convertible bonds, investors have no say in the conversion. Conversion is linked to a specific event (trigger) that is determined in advance. If this occurs, the convertible bond is automatically converted into equities or written-down. For example, a company's equity ratio falling below a certain level could be defined as a trigger. If the equity ratio falls below the equity limit, the convertible bond is converted into equities and the debt capital is automatically converted into equity. If the event does not occur, no conversion takes place. These bonds are typically issued by banks.

CoCo bonds are not part of the Bantleon universe and are often explicitly excluded from convertible bond indices.

Although the market for convertible bonds is a niche segment with a global volume of around USD 400 billion, it is nevertheless sufficiently diversified in terms of region and sector. Most issuers are medium-sized and large companies from high-growth sectors such as IT/technology, industry and pharmaceuticals. While some issuers raise capital several times, many only utilise this opportunity once or twice. The regional and sectoral composition of the convertible bond universe is therefore very dynamic. The US market is currently the largest with a share of around 66%, followed by Europe (approx. 22%). The global universe offers over 500 instruments from 350 issuers; as of August 2024.

In the first six months after interest rate hike cycles (1995, 2000, 2006 and 2018/2019), convertible bonds already achieved a total return that was between that of equities and conventional bonds. If the observation period is extended to 24 months, the results – depending on the convertible bond segment – are similarly good or even significantly better. Global convertible bonds in particular, but also the sub-segment Global Focus, significantly outperform the performance of global equities and conventional bonds on average. Of course, an important part of this relative outperformance can be attributed to 2020, which was exceptionally strong in every respect.

Performance of convertible bonds (CBs) compared to equities and bonds over a period of 6 months

Comparison of the total returns of five indices over a six-month period following a Fed hike cycle. Ticker symbols: Global CBs: UCBIFX01, Global Focus CBs: UCBIFX02, Global Investment Grade CBs: UCBIFX04, Global Equities: NDDUWI, Global Bonds: LEGATRUH. Source: Bloomberg

Performance of convertible bonds (CBs) compared with equities and other bonds over a period of 24 months

Comparison of total returns over a 24-month period for five indices after a Fed hike cycle. Ticker symbols: Global CBs: UCBIFX01, Global Focus CBs: UCBIFX02, Global Investment Grade CBs: UCBIFX04, Global Equities: NDDUWI, Global Bonds: LEGATRUH. Source: Bloomberg

The turnaround in interest rates in the Eurozone and the US should drive convertible bond prices significantly higher again. This is particularly true for the US market be­cause the equities underlying the US convertible bond market are particularly sensi­tive to changes in US government bonds – more so than equities in the S&P500. And because US mid-caps, which issue a large proportion of convertible bonds, are relatively favourably valued and therefore have corresponding catch-up potential. Especially as companies in this segment have been able to steadily increase their profits over the past three years, i.e. their fundamentals have improved significantly. The star­ting point for convertible bonds is also very favourable because the credit risk premiums are majorly higher than for high-yield bonds – despite significantly lower default rates in the past (as of 31 July 2024).

1 Integrated ESG approach: Meets our standard ESG requirements. In addition to standard- and value-based ESG exclusions, sustainability aspects are taken into account in an integrated manner in the investment process, and a diversified convertible bond portfolio with attractive return potential is sought that also takes into account environmental, social and governance criteria.

2 Optimised ESG solution: Goes beyond our standard ESG requirements. The flexible, high-conviction investment approach makes it possible to construct a convertible bond portfolio that not only offers attractive return potential but also actively minimises ESG risks. Full ESG integration, strict security selection requirements and consideration of positioning in relation to the Sustainable Development Goals (SDGs) are important cornerstones of the strategy.

Bantleon employs five convertible bond experts with an average of more than 14 years experience in managing this asset class. The special quality of our three convertible bond funds has been confirmed by the renowned rating agency Lipper, among others: until now 13 fund awards already. For example, our flagship fund Bantleon Global Convertibles Investment Grade has a 5-star rating from Morningstar and was recognised as the best fund in its category in Europe and Switzerland in a 3-year comparison at the Lipper Fund Awards in May 2024. All three fund strategies have outperformed the comparable indices since their inception (as of 31 July 2024).

© 2024 LSEG. LSEG Lipper Fund Awards Winner Germany, Austria, France, Europe, Switzerland, CSIP (Lux) Global Investment Grade Convertible Bond Fund B USD, Best Bond Convertibles Global Fund Over 3 Years