Convertibles 2Q25 Outlook

Performance

The first quarter of 2025 saw stocks and equity-linked convertible bonds drop in response to the Trump Administration’s threats to impose steep tariffs on most U.S. trading partners. A bright spot for convertibles is that they have held up relatively well compared to the decline in equities. Through the recent nadir on April 8^th, 2025, the S&P 500, NASDAQ Composite, and Russell 2000 were down 14.99%. 20.78, and 20.77%, respectively, or an average of 18.85%*. For the same period, the ICE BofA U.S. Convertible Index was down 7.61% for a downside capture of 41% which is somewhat better than the typical downside capture rate of 50%.

Coming into the year, the average convertible bond was trading within five points of its par value providing for decent downside support in the event that underlying equities moved lower. This compares favorably to 2022 when the average bond price began the year well above par, making them sensitive to moves in the underlying equities which afforded little bond protection when stock prices dropped sharply. Given the current balanced nature of most of the market, i.e. bonds trading close to par value, convertible should continue to offer downside support in a falling equity market but still participate in much of the upside should stocks rally off their recent lows.

*Source: Bloomberg

Issuance

Through the end of the first quarter of 2025, new issuance totaled $15.3 billion, (from Bank of America data) or an annualized rate of $60 billion, which while below last year’s $87 billion total, is still a healthy rate of primary issuance. With the onset of volatility in the stock market and the sharp drop in price of many shares, companies may be more reluctant to issue a new equity-linked security, but those companies that need the infusion of cash are still likely to come to the market as it may be their best or perhaps only realistic opportunity to raise funds. The only new issue thus far in April came from electric vehicle manufacturer, Lucid Motors, which sold $1.1 bil of new convertible debt despite a stock price below $2.50.

Should volatility in the equity markets subside, we would expect new issuance to resume a more normal rate as many companies that issued debt during the pandemic need to refinance upcoming maturities.  Companies that cannot refinance that debt from operating cash flow are likely to sell new debt through initial public offerings.

Positioning and Outlook

While the economy was reasonably healthy coming into the year, there remains a significant risk that consumer and business spending declines due to the imposition of new tariffs. Stocks were trading at historically high valuations prior to the recent selloff and arguably are not cheap even after the recent decline. We are not incorporating any macro-economic view into our investment decisions, as our investment process is focused on company-specific fundamentals. In the wake of the recent selloff, however, we have lightened our holdings of several bonds in the Healthcare sector where either company fundamentals have deteriorated or the bonds had fallen to a level where they no longer had much equity sensitivity. We added to several holdings, particularly in the Information Technology sector, where fundamentals remain strong and the issuing company’s bonds have a balanced profile so that they should participate meaningfully in any eventual share price recovery. We remain overweight the Healthcare sector and underweight Utilities and our portfolio has held up relatively well in the recent downturn. We continue to believe that our process which emphasizes strong company fundamentals and reasonable valuation will outperform over a complete market or economic cycle.