What are convertibles?
Convertibles have the characteristics of a fixed income investment. The investor achieves regular interest income and receives his capital repayment at maturity. The special feature of these investment vehicles lies in the built-in option to convert the bonds into a predetermined number of a particular company’s shares. As a result of this built-in option, convertibles behave partly as bonds and partly as shares. Whenever it becomes advantageous for the investor to exercise his right to convert, the value of the convertible will be determined primarily by the developments of the underlying share price. When conversion is not advantageous, the investor shall not exercise his right and will rather accept the repayment of the principal.
Why invest in convertibles?
As opposed to regular bonds, convertibles can deliver a positive performance even in times of rising inflation and resulting falling bond prices. Although convertibles also suffer in these conditions, the investor has the possibility to profit from the increase in value of the underlying stock. The combination of the long term growth potential of equity and the capital protection through the promise of repayment of the bond principal is one of the reasons why convertibles are increasingly used in portfolios of institutional investors.
Superior long term performance and automatic rebalancing
Empirical studies show an interesting result: in times of falling equity markets, the return of a convertible bond exhibits a high correlation to a traditional fixed income investment. In times of rising equity markets, convertibles come closer to an equity investment. An inclusion of convertible bonds in a global asset allocation has historically yielded higher returns and lowered the risk profile.