Despite investor concerns about rising inflation and geopolitical threats to the economic recovery, there are reminders that the glass is still half full for convertible bonds. Macroeconomic data have improved and the recent company earnings seasons in Europe and the US have seen earnings upgrades exceeding the number of downgrades.
Historical equity valuations in Europe are below average, driving investor appetite for risky assets. This has seen stock markets rising sharply for the past two years. However, some investor nervousness remains and rightly so. We think the recent risks are not negligible and need to be monitored.
Momentum not exhausted
Convertible bonds have benefited from positive momentum recently. Returns have shown the structural strengths of the asset class such as diversification. Indeed, current valuations are somewhat high due to the equity support, positive inflows into the asset class and limited new issuance. However, we continue to see attractive opportunities in the balanced and high-yield segments.
We strongly believe convertible bonds remain the asset of choice, especially for investors willing to maintain an exposure to equities while reducing risk, or for those willing to add contained risks to their defensive portfolios.
Pockets of value
We expect it to become harder for investors to to find value. Previously they have profited from buying sprees in the energy, basic materials and financials sectors but this is unlikely to continue. Instead, we believe value can be generated over the next 12 months via carefully selected convertible bonds, focusing on the defensive and balanced profile segments and on appealing fundamental equity stories.