Investing: the benefits of convertible bonds

With stock markets in turmoil, it may make sense for investors to look at this hybrid financial product. 

By Romain Thomas

While bank failures in the US have raised the spectre of a global financial crisis - particularly that of Silicon Valley Bank (SVB) on 10 March - the convertible bond market seems to be gradually regaining favour with investors in Europe.

The benchmark index for these financial products in the euro zone, the Exane ECI Euro, has risen by almost 5% since the beginning of the year. This performance can be explained by the hybrid nature of convertible bonds, which makes them a relatively attractive investment medium for all investors looking for a compromise between security and performance.

Convertible bonds (CBs) theoretically offer investors the possibility of benefiting from the performance potential of the equity market while protecting them against a fall in the stock market through their bond component. (...)

In practice, as with a traditional bond, the CB distributes regular income to investors until the final redemption date of the bond. With one specificity: "It is in the conversion option that the performance potential of the convertible bond resides", explains Nicolas Schrameck, co-head of the convertible & credit division at Ellipsis AM. It gives investors the right to convert, at their convenience, their securities into a predetermined number of shares of the issuing company throughout the life of the CB, at a price fixed at the outset.

A SPECIFIC RISK PROFIL

This price is generally between 20% and 40% higher than the stock market price of the share at the time of issue of the convertible bond. Consequently, if the issuing company's share price rises, the price of its convertible bond will automatically increase.

Conversely, if the share price of the issuing company falls, the conversion option will be worth almost nothing. From then on, the value of the convertible bond will simply be its bond component. (...)

Because of this particular risk profile, bonds can appeal to investors looking for opportunities in the equity markets, without exposing them fully to the ups and downs of the stock market, (...). Another advantage: "The convertible bond market is now very attractive, given the rise in interest rates on the financial markets, which now provides a better return," adds Nicolas Schrameck.

Nevertheless, even if sensitivity to stock market trends is, for the moment, the main driver of convertible bond performance, it is also important to ensure the financial soundness of the company issuing the CB, in particular by accurately assessing the level of its payment default risk.

ACCOR, AIR FRANCE OR CARREFOUR IN FRANCE

On this point, professionals recommend favouring convertible bonds issued by financially solid companies, such as Accor, Air France or Carrefour in France. However, most of the time, the issuing companies operate in fast-growing sectors and wish to finance themselves at a lower cost.

Indeed, in the event of a significant rise in their share price, they would not have to repay their debt associated with the CB, as investors would then have a financial incentive to ask to exercise their conversion option in order to be compensated in shares.

However, in order to avoid disappointment, it is recommended that investors wishing to invest in these financial products turn to a mutual fund specialising in this area. There are several hundred products that implement this type of investment strategy.

The best of them have been performing well in the green since the beginning of 2023. To give yourself the best chance of success, it is probably best to choose a fund of conviction, with a solid track record in this area, such as (...) or Ellipsis European Convertible I (ISIN code: FR0010868802). (...)

1,2 %

This is the median annual management fee for the European-domiciled convertible bond fund category, according to Morningstar. This compares with a median annual management fee of "0.81% for traditional euro bond funds", according to Mara Dobrescu, head of bond fund research at Morningstar.