What do Elon Musk of Tesla, Charlie Ergen of Dish Network, and Jack Dorsey of Square all have in common? Their companies all issued convertible bonds in the first three months of 2017 helping make it a bumper quarter for issuance of this kind of hybrid security.
In all, 34 US companies tapped the market, the most since 2014. They raised $11.1 billion, according to Dealogic. And with equity valuations running hot, that's a trend that looks set to continue. We're in a sweet spot right now where both issuers and investors can do well.
While the Trump administration's difficulty marshalling its agenda has knocked a little of the complacency out of the equity market, investors in convertibles might find that this new uncertainty adds another source of returns.
Now unlike typical bonds, convertibles include an option to convert the investment into shares at maturity instead of just getting the cash back. That gives investors a lot of the upside of a company's share price, but with the safety of knowing that they get their principal back in cash if the stock tanks.
Over the long run, convertibles have tended to capture close to 90% of the upside from an equity market rally without going down nearly as much in bear markets. In fact, they miss out on about 25% of the losses. That's a pattern that's held true so far this year. Q1 returns of 5.3% for convertibles were close to the 6.1% returned by the S&P 500.
Tech companies are amongst the most enthusiastic issuers of convertibles, in part, reflecting the volatility of their shares. The more volatile a stock is, the more valuable is the option to buy it. All else being equal, if uncertainty around the political situation in the US leads to more market volatility generally, that should make convertible bonds more valuable too. It should also encourage more issuance.
Convertibles are one way that companies can "monetise" volatility. Tesla raised about $1 billion in convertible bonds last month to fund the production of its new Model 3 in a deal that attracted a lot of interest from investors. Dish tapped the market for $1 billion too. It seems likely that in Q2 there will be lots more big deals to follow. Stephen Foley for the Financial Times.