Performance
As convertibles have an imbedded call option on the common shares of the issuing company, convertibles can provide upside equity participation while their bond features can help mitigate downside risk. This year with equities advancing, convertibles have participated in some of that upside. The 7.7% return of US Convertible Index compares to the 2.4% advance in the Bloomberg U.S. Aggregate Total Return Index as of June 15th 2023.
As is the case with the S&P 500 and NASDAQ indices, the bulk of the gains in the U.S. Convertible Index have been driven by a few large index constituents. Within the U.S. Convertible Index, approximately one-quarter of year-to-date returns have come from a single issuer, Palo Alto Networks. Our expectation is that as the year progresses and equity advances broaden, gains in the convertible market will become more widespread as well. The U.S. Convertible Index is less concentrated than it was two years ago, with no single issuer constituting more than 3% of the index, which should allow equity advances to be more broadly distributed (note that by comparison, Apple comprises more than seven percent of the S&P 500 Index).
Issuance
New issuance has rebounded from 2022’s unusually low levels. Last saw year saw only $28.7 billion of new convertible issuance in the U.S. The sharp decline from $84.3 billion in 2021 was likely due to the soft equity market, as many companies did not want to issue securities linked to their shares that they believed to be undervalued. Not surprisingly, issuance has picked up this year with more than $23 billion of new convertible securities issued through the first five months of 2023. The likely catalyst for this jump in issuance is the increase in interest rates that companies now must pay to debt investors. By issuing convertible bonds, where investors have the potential for capital appreciation as well as income, companies can sell debt with a lower coupon than what would be required for an issuance of straight debt.
For investors, much of the new issuance this year has been investment grade, which was incredibly scarce for the past decade as investment grade companies could sell non-convertible debt with coupons below 3%. In addition, higher rates have forced issuers to attach higher coupons to their convertible offerings. While convertible coupons remain well below those of high-yield debt, they are significantly higher than they were just one year ago. Lastly, the conversion premiums for most new issues – the amount that the common stock price needs to rise before it becomes advantageous to convert – have returned to more historical norms of 25-35% following 2021’s premiums of 50-70% for many large technology and media new issues.
With an upswing in new issuance with attractive terms, better credit quality and a rising market that may be on the cusp of broadening its gains, the second half of 2023 may be an interesting time for investors to consider an allocation to convertible bonds.
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This material contains the opinions of certain professionals 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. ©2023, MacKay Shields LLC. All Rights Reserved.
Past performance is not indicative of future results.
NOTE TO UK AND EUROPEAN INVESTORS
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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.
USE OF ISSUER NAMES
All security, issuer and company names cited herein are done so for informational purposes only and only to convey factual information. Such names are not intended, nor should they be construed as, a recommendation to buy and sell any individual security or as an indication of current or future profitability. Issuers cited herein do not necessarily represent portfolio positions of MacKay Shields LLC or its affiliates, nor does MacKay Shields express any views, positive or negative, on such issuers.
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.
SOURCE INFORMATION
Source: 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.
“Bloomberg®”, “Bloomberg Indices®”, Bloomberg Fixed Income Indices, Bloomberg Equity Indices and all other Bloomberg indices referenced herein are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by MacKay Shields LLC (“MacKay Shields”). Bloomberg is not affiliated with MacKay Shields, and Bloomberg does not approve, endorse, review, or recommend MacKay Shields or any products, funds or services described herein. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to MacKay Shields or any products, funds or services described herein.
The following indices may be referred to in this document:
The ICE BofA All U.S. Convertibles 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.
Bloomberg U.S. Aggregate Bond Index: The Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. Must have at least one year to final maturity regardless of call features.Must have at least $300 million par amount outstanding. Must be rated investment-grade (Baa3/BBB- or higher) by at least two of the following ratings agencies: Moody's, S&P, Fitch. Must bedollar-denominated and non-convertible.
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.
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