Convertibles: are there opportunities?

2016 saw a number of pivotal moments, including; Brexit, the election of Donald Trump, huge flows of immigrants into Europe, and a surge in extremist political factions. The repercussions of these significant events and themes will affect markets during 2017.

Added to which the Italian situation has not stabilised and there are growing geopolitical tensions that could impact global trade and energy prices. These, combined with what we view as low risk premia in many financial assets, as evidenced by the current valuations for both risky and more importantly “risk-free” assets, suggests some caution is warranted.

Over the last few years markets have been able to rely on the central bank ‘put’ to thwart the normal functioning and clearing mechanisms in markets; but that benign environment seems to be changing. The low level of bond yields is harming the banking system, pension plans, insurance companies and individual savers.

The political consensus is shifting from monetary to fiscal solutions. The environment of excess savings will mitigate rises in yields, however it appears that the downward trajectory in inflation expectations is starting to turn, and in certain countries inflation is rising. Since yields are so low, even a modest rise in inflation would have a very detrimental effect on the real return of large proportions of the bond markets. Normalisation in the level of bond yields could result in significant broader market volatility. Whilst many investors recognise this risk, few appear to be positioned for it.

2016 witnessed a large sell off in convertibles at the beginning of the year; reaching a low in February. Thereafter convertibles gradually recovered, though outflows weighed on the asset class. The post-US election equity rally prevented convertibles ending the year in negative territory but, even with this rebound, the technical valuations of convertibles are not expensive. Whilst there are a range of attractive convertibles globally, we consider some of the most interesting investment opportunities to be in Japan. Convertibles are a way to obtain exposure to equities in a country where the central bank has committed to keep long term government bonds yields at zero.

Miles Geldard – manager of the Jupiter Global Convertibles fund – Jupiter