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Since the beginning of 2019, we’ve seen robust new issuance in the US convertible market. Year to date, total proceeds are above the $11 billion mark1, roughly equivalent to the same period in 2018, a year that ended with approximately $51 billion2 of new paper, setting a decade-high mark. Equally as important for our market is the significant representation of investment grade-rated converts this year. Almost $5 billion, or nearly half of dollars raised by convertible bonds and preferred offerings this year, are rated investment grade.3
Those types of issues have been scarce in the US convertible universe over the past several years, due partly to the low interest rate environment, which has made convertibles less advantageous for top tier credit companies to issue. (When rates are very low, the lower coupon cost savings realized by investment grade companies issuing convertibles tends to shrink, making the asset class less of a cost-advantaged means by which to raise capital.) In fact, according to data from Barclays, investment grade convertibles, as a percentage of the total US market, have declined from 41% at the end of 2008, to approximately 15% at the end of last year.4
Convert market breakup by market credit quality
Source: Barclays Research, Bloomberg L.P.
Mergers, refinancings have helped fuel investment grade issuance
Why are we seeing this increased participation among investment grade companies, especially in the absence of higher interest rates? One major reason is that companies are using proceeds from recent convert offerings to help finance mergers and acquisitions (M&A). Large acquisitions are often funded through multiple markets (equity, non-convertible and convertible debt, etc.) in order to tap into different investor pools and convertibles are sometimes part of the package. Convertibles, especially mandatory convertible preferred shares, tend to be viewed favorably by rating agencies, which often assign a high percentage of equity credit to them. This may help the company maintain strong credit metrics. Aside from M&A, we’ve also seen investment grade issuance from companies seeking to refinance existing debt, including other convertibles.
Additionally, investment grade converts can generate more demand for the product. Certain convertible investors, including insurance companies and pension funds, often need to maintain minimum credit ratings within their investment portfolios, and a pick-up in investment grade convertible issuance could provide those investors with more opportunities to put money into the asset class.
The potential benefits of investment grade issuance
The rise in investment grade issuance also provides the Invesco Convertible Securities team with a more diverse set of investment opportunities. We are using these new investment grade issues to replace older issues that are reaching their price targets. While we do not specifically target investment grade issuers, when possible we will utilize them to help lift the portfolio’s credit quality.
Another potential benefit to the increase in investment grade-rated issuance is more diversification to the convertible universe’s sector mix. Traditionally, convertible issuance in the US has mostly come from the technology and health care sectors given their more speculative business models and financial conditions. In fact, those two sectors comprised more than half of the issues in the ICE BAML U.S. Convertibles Index as of the end of 2018.2 However, that mix is different among investment grade convertibles, and the recent flurry of companies issuing them has included electric utilities, financials and industrial companies. That sector diversification, in addition to the welcomed addition of some highly rated credits to the convert market, has given us a broader range of investments to consider.
1 Source: Barclays, as of March 22, 2019
2 Source: Bank of America Merrill Lynch Chartbook, as of Dec. 31, 2018
3 Source: Invesco research
4 Source: Barclays, “US Convertibles Outlook 2019: In the Wheelhouse,” Dec. 13, 2018
Blog header image: Ridwan Meah/Unsplash.com
A convertible bond is a corporate bond that has the added feature of being convertible into a fixed number of shares of common stock.
An investment grade bond is generally recognized as such if its credit rating is BBB- or higher (Standard & Poor’s) or Baa3 or higher (Moody’s). These bonds are judged by the rating agency as likely to meet the associated payment obligations.
The ICE BAML US Convertible Index is an unmanaged index that measures performance of US dollar-denominated convertible securities not currently in bankruptcy with a total market value greater than $50 million at issuance.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Diversification does not guarantee a profit or eliminate the risk of loss.
Past performance is not a guarantee of future results.
Stuart Novick, CFA
Stuart Novick is a Senior Analyst working with the Invesco Convertible Securities team.
Mr. Novick joined Invesco in 2014 and entered the industry in 1989. He was previously a senior credit analyst at Bloomberg, covering special situations in the Bloomberg Industries research group. Prior to that, he was a credit analyst at the Financial Times Group. Mr. Novick started in the industry in 1989 and spent 17 years at Citigroup, where he was a director in the convertible securities group.
Mr. Novick earned a BS degree from the University of Albany and an MBA from Columbia Business School. He holds the CFA designation.