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The impending hard-Brexit, a worsening political crisis in the US, the US trade dispute with China and fears of a global recession – there is currently no lack of negative news that is clouding sentiment on the investment markets. In this environment, an asset class that still leads a shadowy existence among many investors is performing particularly well – the convertible bond.
Excellent third-quarter performance
The Thomson Reuters Convertible Bond Index (USD hedged) returned 1.45% in the third quarter, bringing performance to 8.66% since the beginning of the year. Investment Grad (IG) Convertible bonds had an excellent quarter, reaching new highs and outperforming balanced convertible bonds (Global Focus) by around 1%. Since the beginning of the year, IG convertible bonds are now in the lead again. Secondary market valuations remained stable, but the increase in realized volatility and also bond floors (due to lower interest rates) led to a slight depreciation of convertible prices relative to the theoretical price. In a regional comparison, the US segment in particular was cheaper, not least due to the flood of emissions in the last few weeks of the third quarter.
In terms of trade war, the US President has recently promised to seek an early solution with China. This sparked market recovery in the final days of the third quarter, despite the impending impeachment of the US president. US government bond yields have recovered somewhat in the meantime, but remain at low levels.
AgaNola investment grade strategy is bearing fruit
The AgaNola Investment-Grade Convertible Strategy returned 1.36% in Q3 (hedged before deduction of management fees in USD). The highest positive contribution (+5 basis points) was made by a shift in the convertible bonds of US biotechnology company Illumina. “During the quarter, we gradually withdrew from the stock-sensitive convertible with ’21 expiration and moved into the much more balanced and defensive convertible with maturity ’23. This paid off as Illumina shares came under pressure in succession and the convertible bond appreciated significantly,” explains convertible bond specialist and senior portfolio manager Lukas Buxtorf. A total of 10 basis points contributed three off-benchmark positions in the gold mining convertible bonds of SSR Mining, First Majestic and Polyus, all of which benefited from higher gold prices. “We realized a small portion of the gains towards the end of the quarter, but given the geopolitical situation, we remain confident that gold will continue to be in demand,” says Buxtorf. On the other hand, the underweight to the Perpetual convertible from Wells Fargo was the main negative factor. The bond gained around 10% as a result of falling interest rates, making it one of the best performing instruments in our third-quarter benchmark index. Furthermore, an underweight of Ares Capital came at a cost. Ares Capital and the entire BDC (Business Development Companies) sector have benefited from the low interest rate environment. After the increase in the stock, the conversion premium is back at about 20%, and the risk profile appears again extremely interesting. Lukas Buxtorf: “We have now turned the underweight into a slight overweight.
Cautious market outlook with convertible bonds as a ray of hope
Global growth prospects have deteriorated globally and the central banks, notably the US Federal Reserve and the ECB, have already taken appropriate action and further interest rate cuts and bond repurchases are expected. This has pushed yields further down the long end of the yield curve, with the result that bonds worth almost USD 17 billion (of which approximately USD 1 billion are corporate bonds) have a negative maturity yield. Meanwhile, the average delta of the IG universe fell another 2% in Q3 and is currently at a ten-year low. “In this challenging market environment, we are nevertheless confident that our positioning is right – in terms of convertible bonds as our asset class and Investment Grade as our strategy,” says AgaNola CEO Oliver Gasser.
AgaNola AG is a privately held asset manager based in Pfäffikon, Schwyz. In addition to the specialties convertible and corporate bonds, various funds are on offer. AgaNola’s services range from product-level advice and managed accounts to advising investment committees. AgaNola clients include pension funds and private investors, such as HNWI and Family Offices.
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