Mark Wightman of SunGard looks at the growing demand for convertible bonds among private clients in Asia, and explains how wealth managers can sell these products appropriately.
Date: Mar 2011
Towards the end of the financial crisis, with markets having dropped significantly, a number of private banks started to look again at these structures because of the large number of high-quality names suddenly available at big discounts, he explained.
As a result, various private banks were suggesting convertible themes. And following a pick-up in the markets, a lot of bonds returned from 60% to 70% of face value to near par – meaning that a lot of investors made some healthy returns simply by adopting a buy-and-hold strategy.
Today, Wightman said convertibles are increasingly being talked about in line with the growth in issuance – with a lot of Asian companies issuing convertibles as a way to raise capital.
Compared with five years ago, for example, he said that a lot of these bonds are also paying a decent coupon and have more realistic expectations in relation to premiums.
How advisers can evaluate convertibles
Being able to advise clients on these products, therefore, requires relationship managers (RMs) and other advisers to understand what drives the valuations and why these products might add value to their clients’ portfolios, he said.
While there is a lot of potential value in the convertible space, Wightman said it is possible that part of the reason why many clients haven’t previously been exposed to such products is because RMs have been a bit nervous to sell them, given their added complexity.
At the same time, he added, there have been a number of high-coupon structures from less creditworthy names – so advisers need to be careful about just looking at the high yield with little regard to risk-reward profiles.
When looking at the valuations of convertibles, assuming they trade at par, then 90% of the value will typically be from the fixed income element, in terms of the bond floor, with 10% coming from the equity option, said Wightman.
This therefore makes the product suitable for investors who might be interested in a certain equity story, but are unsure about the landscape. They therefore know that if they use a convertible they will get a slightly lower yield than buying a straight bond, but with equity upside if the markets move upwards, he explained.
So this makes convertibles suitable for a more conservative investor, said Wightman, who isn’t sure of where the market is going so still wants some potential upside but with a certain level of protection if the market moves against them.
Trends in convertible structures
Post-2008, Wightman said the market has seen a return to the simpler convertible bond structures – often meaning a five-year maturity with a 2% coupon and a conversion premium of 20% to 30%, without puts or resets, and an issuer call at par after a six-month, hard non-call period.
At the same time, he added, the issuer call tends in today’s markets to have a trigger built in, meaning that the issuer cannot call the bond back from the investor unless the share price has reached a certain level, in turn protecting investors.
A concern investors used to have with convertible structures related to dividends, said Wightman, and the fact that holders in a convertible linked to a high dividend-paying stock would miss out on these payments.
Today, however, a lot of convertibles have dividend pass-through features, he explained. This means that all or a significant chunk of the dividends are either paid out at cash, or that the conversion price of the option is adjusted to reflect this. Investors therefore benefit from any increases in the dividends.