Flash – CONVERTIBLE BONDS | JANUARY 2021

An asset class that has proved its resilience all along the covid-19 crisis

 The benefits of the convexity provided by convertible bonds have never been more obvious than during the COVID-19 crisis. For example, during the first quarter of 2020, convertibles proved to be particularly resilient, mainly due to their unique structure, which gives them an attractive risk/return profile.

Titre : évolution des indices actions européennes vs obligations convertibles du 31/12/2019 au 31/12/2020

Source : Bloomberg

The main global indexes suffered considerable losses, with the MSCI Europe down by as much as -32.6% (as on 18/03). On the fixed income markets, credit spreads widened substantially (the Xover index was over 700 bp on March 18^th 2020). In this context, the intrinsic convexity of convertible bonds has once again played an effective role as a shock absorber. The Exane Europe index recorded a drop of -7.8% YTD 2020 as of 23/03, and the Exane Zone Euro index had a negative performance of -7.1% over the same period. The bond floor therefore performed its function to full effect during this phase of stress on the market.

The excellent resilience of convertible bonds during strong market downturns has enabled them to perform better than equities over 2020 but also over longer periods, as can be seen in the graphs below.

Title: Performance of European equity indexes vs convertible bonds indexes from 31/12/2019 to 31/12/2020

Source: Bloomberg

 

A dynamic primary market

 With more than 23 billion euros issued via a total of 47 issues, the primary market showed a good dynamic over 2020, despite the slowdown during February and March. The underlying pool of convertible bonds is now more diversified, with new issuers having a significant growth potential over the long term (Hellofresh, Zalando, Ocado, Zur Rose etc.).

At the same time, approximately 9.4 billion euros of capital were withdrawn from the market (redemption, conversion, exercise of call options etc.), which, has therefore led to an increase in the European convertible bonds universe.

Title: Primary market dynamics from 01/01/2020 to 31/12/2020

Source : Groupama Asset Management

Moreover, during the market stress (March – April 2020), we observed a slight increase in the implicit volatility of convertible bonds, but to a far lesser extent than for the equivalent listed options. This major reduction in value, a first since 2012, was reduced when equity markets recovered.

Despite the decline in growth outlooks due to the COVID-19, the sanitary crisis that we are currently experiencing represents a clear accelerator of structural changes in the way we use energy and technologies. In this context, the convertible bonds universe offers investors a privileged access to companies whose activities are incorporated in those structural changes, where the long-term trends are also strong, such as e-commerce, home deliveries, video games, renewable energies etc.

Convertible bonds offers the ability to invest in companies that are at the heart of the digital and environmental transformation of the economy, while at the same time benefitting from the convexity of the asset class.

 

The performance of our funds in a particularly uncertain market environment

 

1. Groupama Convertibles

In 2020, the fund had a net performance of +9.62 (share class M) and outperformed its reference index, Exane Eurozone Convertible Bond, by + 356 bp.

Title: 2020 performance of Groupama Convertibles (M)

Source : Bloomberg

Past performance are not a reliable indicator of future performance.

 

If we look at the funds’ behavior over the year, we can identify 4 different periods.

The first period, up to March 23^rd 2020, was marked by the global spread of the COVID-19 virus and the global general lockdown of populations and their economies. On the financial markets, this period was reflected in a massive drawdown of the world’s main stock markets, starting in the second half of February. During this period, the Groupama Convertibles considerably outperformed its reference index (+246 bp), in particular due to the hedging strategies in the portfolio (+141 bp) and the overall cautious positioning of the fund.

The second period, from end of March to mid-May, was marked by the progressive reopening of economies and a partial recovery in the economic activity, leading to a market rebound. During this period, our fund was caught in the trough of the markets (-138 bp), due to the selection effects selection (Korian, Nexity, Airbus and Takeaway) and strong underexposure to risk at the start of the market rebound phase.

During the third period, from mid-May to October 30^th, the markets continued their upward trend. In this period, the fund significantly outperformed its reference index (+282 bp), due essentially to a strong improvement in the selection risk (reduction in credit spreads, overexposure to convertible bonds issued by companies belonging to the new economy) and, more marginally, to an overexposure in terms of delta.

Finally, the last period, from end of October to end of December 2020, was marked by positive news concerning the anti-COVID-19 vaccine and its effectiveness. This gave investors a degree of transparency and visibility for the months ahead. This has led towards a strong market rotation of an unprecedented scale and in a very short period of time. The market switched from the “Covid-friendly” stocks (stocks that had up  until now benefitted from the lockdown measures and sanitary situation) towards securities that had particularly suffered due to the lockdown measures. This rotation benefitted several specific sectors and value stocks, whereas growth securities as the whole lagged. Over this period, we made significant adjustments to the portfolio to match this change in the markets, thereby limiting the underperformance to -35 bp during this period of value rally.

 

2. g fund – european convertible bonds

In 2020, the fund had a net performance of +8.17% (share class I) and outperformed its reference index, ECI Europe, by +316 bp.

Title: 2020 performance of G Fund – European Convertible Bonds (I)

Source : Bloomberg

Past performance are not a reliable indicator of future performance.

 

After holding up well during the first two thirds of the downturn (gains on hedging strategies +140 bp) during the first period, the portfolio was caught in the trough of the markets due to its overexposure to the aeronautic sector (Airbus, Safran, TAP, Akka tech etc.) and poor performance on specific issuers, such as Korian, Nexity and Genfit during the second period.

During the third period, from mid-May to October 30^th, the fund recorded significant outperformance of +331 bp, despite the Wirecard case (-27 bp), due essentially to a considerable improvement in the selection risk (reduction in credit spreads and overexposure to the new economy) and, more marginally, to an overexposure in the funds’ elta and credit risk.

Finally, during the last period, which was marked by rally value, we have made some major portfolio adjustments (purchase of energy, aviation, automotive, telecom and UK stocks, while reducing our exposure to “stay-at-home” securities) and was therefore able to take advantage of the general market rotation (+115 bp).

 

Outlook and positioning

Thanks to their positioning and reinforced convexity, our convertible funds performed very well during the period of high volatility. Today, there are still major uncertainties, even if the central banks and governments are showing their massive support (massive recovery plans, support for the sectors that are particularly hit by the health crisis, such as aviation and tourism, the purchase of sovereign debt and credit by central banks etc.) and vaccine announcements are providing greater visibility regarding a potential “return to normal”.

In this context, we are maintaining an active investment strategy.

• A slightly long risk positioning on G Fund – European Convertible Bonds via an over exposure in delta and credit risk.
• A cautious bias on Groupama Convertibles via an under-exposure in delta and also a lower credit exposure.
• In order to improve the convexity of the portfolios, protections remain in place to mitigate potential market shocks.
• The duration risk remains well below the benchmark.
• Replicated pocket: credit allocation remains low (unattractive credit spreads) and a lower weighting of the equity option leg is also noted. The level of investment in convertibles (90% of the portfolios) reflects their attractiveness (renewal of the deposit and technical valuations that remain reasonable due to the abundance of primary) and the high level of option volatility.

The main fund risks are:

– Interest rate risk: A  rise in interest rates on the fixed income markets can lead to a fall in bond prices

– Credit risk: Any downgrading of the issuer’s signature can have a negative impact on the value of the security

– Liquidity risk: Depending on the specific period, bonds can be less liquid than certain equity markets, and this can affect the net asset value of the fund or compartment, in the case of large-scale redemptions.

– Capital risk: The compartment or fund does not provide any guarantee or capital protection. Ultimately, investors might not recover their initial investment.

– Risk intrinsic to investment in convertible bonds The elements determining the value of the convertible bonds (interest rates, trend in the prices of the underlying shares and trend in the price of the derivative integrated in the convertible bond) can lead to a reduction in the net asset value of the fund or compartment.

Equity risk: Variation in share values can have a positive or negative impact on the net asset value of the fund.

 

By Nina MAJSTOROVIC, Product Specialist at Groupama Asset Management.

 

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