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February 5, 2009 2:00 am
Leading fund managers believe convertible bonds will be the asset class of 2009 as companies attempt to plug an estimated £50bn ($73bn) refinancing gap from sources other than equities.
The collapse in equity demand from investors has led companies to revisit the convertible bond sector as a means of raising capital, without being penalised by having to attract investors with high coupons.
"Companies can get away with a lower coupon," says Colin Morton, investment director at Rensburg Fund Management. "Instead of having to offer 9-10 per cent, convertible bonds can offer 6-7 per cent because you have the additional bonus of being able to convert into ordinary shares if they get to a certain price."
This flexibility in the face of the refinancing crisis means many managers are looking keenly at the convertibles market.
"Over the next economic cycle, convertible bonds are going to be a fantastic investment," says Antony Vallee, vice-president and manager of convertible bond portfolios at JPMorgan Asset Management.
He agrees that the shortage of capital is the main driver. "There is a huge refinancing need at present," Mr Vallee says.
In addition, there is a high correlation between the equity and convertible bond markets. "This means we are seeing more convertible bonds as an alternative to the equities rather than bonds, and for investors that is key. Everything depends on what the equity and credit markets will do and what the risk appetite will be in 2009."
Many convertible bonds are fundamentally undervalued after a torrid year. "Compared with straight debt, they are trading very cheaply," says Dan Mannix, head of business development at RWC Partners, the hedge fund. "They are trading below the bond floor, when typically you would expect them to trade at a 5-15 per cent premium."
An aversion to both debt and equity in 2008 drove many asset classes, including convertibles, lower. So much so that RWC is launching a distressed convertibles fund this month.
"The wave of selling caused prices to fall further than they should have," Mr Mannix says.
In turn that created a raft of opportunities for investors. "We're seeing over $100m of net inflows coming into our existing RWC Global Convertibles fund each month. This was particularly true for the last quarter of 2008, when other funds saw significant outflows."
In spite of increased demand, continued hedge fund deleveraging is expected to drive prices down. Barclays Capital's convertible market outlook for 2009 says: "Attractive convertible opportunities arose from the severe market cheapening; while some of these have been realised in the recent valuation bounce, others remain."
The report notes that a range of new investors were being attracted. "Non-traditional investors will also likely remain interested in the asset class, including the substantial set of active, high-yielding convertibles."
Mr Mannix agrees. "We're seeing a significant increase in demand for convertible bonds from a variety of investors who haven't used them before," he says. Examples he gives are pension funds, institutional multiasset funds and private banks and individuals.
"Across the spectrum we're seeing crossover buyers who would have traditionally invested in equities or straight debt seeing true value in convertible bonds."
Hugo Greenhalgh is editor of Investment Adviser
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