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Well equipped with hermaphrodites: convertible bonds: which are now particularly suitable | message


by Andreas Hohenadl, Euro on Sunday

When events of massive caliber shake the world, asset classes don’t always behave like the textbook. Take gold, for example: The price of the “refugee currency” normally benefits from this as uncertainty increases. But what happened after the first violent market slumps as a result of the corona crisis? The precious metal became cheaper. The quotations suffered from emergency sales by investors who urgently needed liquidity.

It is all the more gratifying if an investment category delivers what it should in times like these: to keep losses for investors within limits. Convertibles are known for this very property. A rule of thumb says: A portfolio made up of these stocks participates in two-thirds of the upward movement when prices on the stock market rise, but only one-third of the downward movement when prices fall.

“This rule of thumb gives a good indication”, says Manuel Zell, fund manager and convertible bond expert at the Frankfurt company Lupus alpha. “In the current crisis, convertible bonds have lost significantly less than their value compared to other asset classes.” Indeed, while stock indices such as the Euro Stoxx 50 slumped more than 25 percent in the first quarter and even bond investors in the high-interest segment suffered losses of 15 percent, global convertible bonds only fell about 9 percent. This is the result of whoever looks at the common index.

Security and attractive opportunities

The fact that convertible bonds, also known as convertible bonds or converters, can offer this crash buffer is due to their special design: they are hybrid between bonds and stocks and combine security and attractive return opportunities in one paper. Just like conventional corporate bonds, converters offer a fixed coupon and a specific term. At the end, they will be paid back 100 percent.

In contrast to normal corporate bonds, convertible bonds have an option. This gives investors the right to exchange the bond for shares in the company within a specified period at the specified ratio. So you can benefit from rising share prices with converters.

But what if the stock or the stock market does not develop as hoped? Then investors simply hold the bond, collect the interest and have the money paid back when it is due.

The value of a convertible bond is Depends on both the stock and bond markets, and many factors have an impact on the price. In addition, the papers are designed very individually, often with thick brochures and many clauses. And last but not least, the minimum denomination for converters is usually 100,000 euros and more. This makes the convertibles market difficult to access for private investors. It is therefore advisable to start with mutual funds. These also ensure the necessary risk diversification.

A balanced risk-return profile and Manuel Zell, Marc-Alexander Knieß and Stefan Schauer are aiming for a broad base with their Lupus alpha Global Convertibles fund. It is important to them that the converters in the portfolio are located in the convex area. This means that the price of the paper has to be within a certain range so that the desired asymmetrical behavior (greater opportunities than risks) is shown. If the price is too high, the converter looks like a stock, if it is too low, it behaves like a bond.

A thorough credit analysis is also important because “the bond floor must be secure,” says fund manager Zell. He means the lower limit for convertible bonds. Convertible prices also fall as markets collapse. Because an exchange for shares is less likely. But the price drop only goes up to a certain limit, the bond floor. This is the value of the underlying bond that the investor will receive at least at the end of the term.

Good time to get started

Unless the issuer goes bankrupt in the meantime. Such risks also affect converters. “Recently we saw isolated failures on the market, especially in the energy sector, which is suffering from the massive drop in oil prices,” explains fund manager Zell. Engagements in hotel chains or airlines that are directly affected by the corona pandemic are currently more risky.

Otherwise, Zell and his colleagues currently consider the starting point for converters to be cheap. This speaks not only for the opportunity to benefit from recovering share prices and at the same time to enjoy the security of bonds. The valuations on the convertible bond market are currently also exceptionally cheap: On average, the paper traded well below its theoretical prices. If there is a normalization here, Zell says, this will already bring a few percentage points of return, even if the stock market only moves sideways.

Investor info

Convertible bonds against stocks
Less risk pays off

The chart shows the long-term performance of global convertible bonds – measured by the corresponding Thomson Reuters index – and the global stock market in the form of the MSCI World Index. The indices are hedged on a euro basis or in euros.
It shows that convertible bonds lose less than shares in market slumps, which gives them very good returns in the long term.

With this portfolio, Marc-Alexander Knieß, Stefan Schauer and Manuel Zell offer a “pure play” for convertible bonds: They strive for a balanced risk-return profile, invest in attractive paper worldwide, particularly from growth companies, and largely hedge currency risks. In their view, currency fluctuations would distort the convex profile (higher chances of winning than risk of loss).

This ETF, which tracks Thomson Reuters’ common index for global convertible bonds, gives investors a cheap and broad-based alternative to actively managed funds. The portfolio is made up of around 220 stocks, with the United States being the most heavily weighted at just under 50 percent. Information technology dominates in the industries. The fund currency is US dollars. In contrast to the Lupus Alpha Fund, currency effects also play a role.


Image sources: Sergey Nivens /, Jirsak /

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