Performance
At first glance, with the U.S. Convertible Index[1] up 2.13% through the first half of 2024, it would appear that the asset class is falling short of its traditional 60-80% upside capture of equity returns. However, a closer look at YTD equity returns shows a very different picture than what the S&P 500’s 15.3% advance would suggest. Looking at the S&P 500’s returns on an equal-weighted basis puts the benchmark up 5.07%, just one-third on the Index’s headline number. Looking beyond mega-cap stocks, the smaller-cap Russell 2000 is up a mere 1.73% through the first six months of 2024.[2] These returns highlight the influence that just three companies, Nvidia, Meta, and Microsoft, had on the large cap equity indices. The equal-weighted S&P 500 and Russell 2000 returns are a truer indication of how most stocks have done through the first six months of 2024. Considering the more prevalent low to mid-single-digit equity returns, the U.S. Convertible market return of 2.13% reflects a fairly typical upside capture scenario.
As smaller and midcap stocks trade at a significantly lower valuation to large-cap equities, our expectation is that a narrowing of the valuation gap will lead to improved smaller equity cap and convertible performance relative to the S&P 500 and NASDAQ indices.
Issuance
Issuance of convertible securities for the first half of 2024 has been particularly strong with approximately $40 billion of new issuance coming to the market. Higher interest rates and a wave of maturing debt have companies searching for less costly avenues to refinance that debt. Higher rates have been a motivating factor for companies seeking financing in our asset class, as they can usually issue a convertible bond with a meaningfully lower coupon than they would be required to pay in the straight high yield or investment grade market. Lastly, with stocks at record levels, companies are comfortable issuing an equity-linked security.
Our expectation is that issuance will meet or exceed $80 billion this year which compares to $53.4 billion of new issuance in 2023 and $28.7 billion of new issuance in 2022. We do not expect a dropoff in the pace of new issuance as the factors that are driving new offerings, the need to refinance coming maturities and higher rates, are unlikely to subside in the near future. New issuance is generally a positive for the convertible market, as most new securities are priced at a discount to their theoretical fair value and generally trade above the issue price on their first days of trading, providing a small boost to Index returns. In addition, new bonds priced at par are balanced securities that usually offer an asymmetric return profile, whereby the bond will capture a greater percentage of the underlying equity’s upside than downside. Lastly, with higher prevailing interest rates, most new issues are coming to market with higher coupons and lower conversion premiums - the amount that the common stock price needs to go up before it becomes advantageous to convert than what was prevalent in the post-financial crisis environment of ultra-low interest rates.
[1] The ICE BofA All U.S. Convertibles(VXA0) Index. See index definition at the end of this document.
[2] Source: Bloomberg, using the S&P 500 Equal Weight Index (EWI) and the Russell 2000 (RTY) respectively, assuming dividends reinvested, from 1/2/24 - 6/28/24.
Positioning and Outlook
While the economy appears to be slowing but still relatively healthy, we are not incorporating any macroeconomic views into our investment decisions as our investment process is focused on company-specific fundamentals. While corporate earnings have generally been better than expected, much of that good news may already be reflected in stock prices, absent a cut in interest rates in reaction to a slowing economy. We are also agnostic about the outcome of the Presidential and Congressional elections in November. We believe that the outcomes of elections often have little impact on the economic cycle and securities markets, or have an outcome that is counter to general expectations. As such, we continue to invest in companies with strong fundamentals and attractive valuations which has led to a large overweight to the Healthcare sector and an underweighting to the Consumer Discretionary and Financial sectors. We believe that companies with strong fundamentals and attractive free cash yields can continue to deliver mid to high-single-digit returns for the balance of the year.
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This material contains the opinions of certain professionals at MacKay Shields but not necessarily those of MacKay Shields LLC. The opinions expressed herein are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and opinions contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Any forward-looking statements speak only as of the date they are made and MacKay Shields assumes no duty and does not undertake to update forward-looking statements. No part of this document may be reproduced in any form, or referred to in any other publication, without express written permission of MacKay Shields LLC. ©2024, MacKay Shields LLC. All Rights Reserved.
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NOTE TO UK AND EUROPEAN AUDIENCE
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COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
SOURCE INFORMATION
ICE Data Indices, LLC (“ICE Data”), is used with permission. ICE® is a registered trademark of ICE Data or its affiliates, and BofA® is a registered trademark of Bank of America Corporation licensed by Bank of America Corporation and its affiliates (“BofA”) and may not be used without BofA’s prior written approval. ICE Data, its affiliates and their respective third-party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ice data, its affiliates nor their respective third-party suppliers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third-party suppliers do not sponsor, endorse, or recommend MacKay Shields LLC, or any of its products or services.
about RISK
Convertible securities are subject to a risk of loss. Convertible securities may be subordinate to other securities. The total return for a convertible security depends, in part, upon the performance of the underlying stock into which it can be converted. Additionally, an issuer may encounter financial difficulties which could affect its ability to make interest and principal payments. If an issuer stops making interest and/or principal payments, an investor could lose its entire investment.
The following indices may be referred to in this document:
The ICE BofA All U.S. Convertibles (VXA0) Index is an unmanaged index that consists of convertible bonds traded in the U.S. dollar denominated investment grade and non-investment grade convertible securities sold into the U.S. market and publicly traded in the United States. The Index constituents are market value weighted based on the convertible securities prices and outstanding shares, and the underlying index is rebalanced daily.
The S&P 500 Index is an unmanaged index that is widely regarded as the standard for measuring large-cap U.S. stock market performance.
NASDAQ Composite Index: The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market.
RUSSELL 2000 INDEX: The Russell 2000 Index is an unmanaged and market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of the entire US stock market. More specifically, this index encompasses the 2,000 largest US-traded stocks, in which the underlying companies are all incorporated in the US
MacKay Shields LLC is a wholly owned subsidiary of New York Life Investment Management Holdings LLC, which is wholly owned by New York Life Insurance Company. "New York Life Investments" is both a service mark, and the common trade name of certain investment advisers affiliated with New York Life Insurance Company. Investments are not guaranteed by New York Life Insurance Company or New York Life Investments.
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