Convertible bonds are fast replacing corporate bonds as the latest asset class for investors. Drawn by news stories of the Qataris buying into Barclays and Warren Buffett investing into Goldman Sachs using convertibles, the lure of the bond/equity mix has proved irresistible.

The asset class gained particular traction towards the end of last year, when, following massive deleveraging by hedge funds, managers were able to pick up convertibles at bargain basement prices. “It was plain the asset class suffered last year,” says Nathalia Barazal, manager of the Lombard Odier Darier Hentsch Invest – Convertible Bond fund. “In September and October every asset class was affected by the panic selling by hedge funds, and convertibles, which were common strategies within many hedge funds, were particularly hit.”

It became a buyer’s market, as everyone tried to unload their convertibles at the same time. “They could not sell at the right price,” says Ms Barazal, “so they started offering bonds at a discount in September and then even more so in October. “At that point, investors could snap up convertible bonds at prices way below the bond floor.”

As the convertible bond price is made up of the price of the option plus the value of the bond, this now meant investors could buy the convertible at a price below the value of the bond. “This means you could get a higher yield in the convertible bond versus the straight debt,” says Ms Barazal. “You could get free options and a discount on the bond value. It didn’t even matter what the option was – it was just free because the bond was below the normal price.”

This unique buying opportunity aside, the fund aims for what Lombard Odier terms “asymmetrical performance”, or profiting from equity market upturns while benefiting from the downside protection of a fixed-
income structure.

“It is a way of having equity exposure but also protection,” says Ms Barazal. “We never lose sight of this second factor, focusing on the combination of equity sensitivity and bond protection, which means we tend to avoid equity proxies, for instance.”

The macroeconomic environment is also “very important”.

“It’s not always so for many funds as almost all of them are benchmarked,” the manager says. “We are very unusual in that respect, because the first thing that matters is a strong conviction, not the benchmark. We invest with a view on everything we buy.”

Ms Barazal remains cautious on the general outlook, despite a slight uptick in the market over the past six months. “The picture has been darker,” she says, “but we are not out of the woods yet, despite the three-week rally in equity stocks that has given a lot of hope for everyone.

“We are in still a market environment that is very fretful and the macro figures are deteriorating. Even though the credit market is softening a bit, there is still a high level of stress with unemployment on the rise. There is still a strong possibility for disappointment. Today, compared with five months ago, we are more willing to take a bit of equity sensitivity, but we are still quite bearish.”

Hugo Greenhalgh is editor of Investment Adviser

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