13.10 convertibles and the great rotation

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Transcript of 13.10 convertibles and the great rotation

  • 1. For Professional Investors and Advisers OnlyConvertibles and the Great Rotation OCTOBER 2013

2. RWC Convertible Bond asymmetric return profileJunk distressed credits with high likelihood of a company default. Bond proxy parity value significantly below bond floor and therefore insensitive to movements in the underlying equity. Delta range between 0% and 20%. Balanced convertibles most attractive risk/return profile. Rate of change in sensitivity to equity price accelerates as equity rises and decelerates as equity falls. Delta range between 20% and 70%. Equity proxy virtual equity with delta 70% - 100%. Importantly bond floor significantly below the convertible price and therefore provides little support as equity falls.RWC | 1 3. RWC Why invest in Convertible Bonds? Ideal for Multi-Asset PortfoliosAnnualised Return & Volatility of Global Equities, Convertibles & Bonds (1996 June 2013)Why buy convertibles: Upside potential of equities and downside protection of bonds Provides an asymmetric risk/return profile Strong risk adjusted returns Low duration asset class Lower duration exposure within a fixed income portfolio Low correlation with other fixed income instruments Increases diversification within a multi-asset portfolio Improves efficient frontier Provides exposure to volatility through embedded call options Long-only investors can benefit from volatility exposure Equity exposure without taking all the downside risk if equities fall Puts, resets and takeover ratchets (which can be particularly attractive in this market environment)20%0.4518%0.4016%0.3514%0.3012% 0.25 10% 0.20 8% 0.156%0.104%0.052% 0%Convertible Bonds Annualised Return (LHS)Equities Annualised Std. Dev. (LHS)Government Bonds0.00Sharpe Ratio (RHS)Source: Bloomberg, UBS, RWCRWC | 2 4. RWC Performance Comparison Global Convertible Bonds vs. Global Equities 280 260 240 220 200 180 160 140 120 100 80 60 40 20 0Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13UBS Global Focus Convertible IndexMSCI World Equity IndexSource: UBS, Citi, RWC, September 2013RWC | 3 5. RWC Performance Comparison RWC Asia Convertibles vs. MSCI Asia Ex-Japan Equity Index 110 105 100 95 90 85 80 75 70 65 60 Jun-11Aug-11Oct-11Dec-11Feb-12Apr-12Jun-12Aug-12MSCI Asia Ex-Japan Equity IndexOct-12Dec-12Feb-13Apr-13Jun-13Aug-13RWC Asia ConvertiblesSource: UBS, Citi, RWC, September 2013RWC | 4 6. RWC Convertible Bonds Correlation AnalysisCorrelation with Convertibles BondsAnnualised VolatilityGlobal Convertible Bonds1.008.89Global 7-10yr Corporate Bonds0.135.52Global 3-5yr Corporate Bonds0.084.99Global 7-10yr Sovereign Bonds-0.0611.58Global 3-5yr Sovereign Bonds-0.0410.65US Treasuries/Agencies 7-10yr-0.226.25US Treasuries/Agencies 3-5yr-0.233.32US 3month T-Bills-0.080.34Asset ClassSource: Bloomberg, MSCI, BoA-ML, RWC. Data as at end of 1996 to end of 2012. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.RWC | 5 7. RWC Convertible Bonds Through Monetary CyclesPerformance Through Monetary CyclesPerformance in Different Interest Rate Environments 53004.5EquitiesConvertible BondsCorporate Bonds-13.7%-2.4%28.7%-51.2%-28.4%-4.7%1.5 January 1997 - August 199957.2%36.1%13.6%125096.7%46.5%29.7%August 1999 - February 20012.7%13.2%4.2%August 2004 - September 200773.3%34.3%15.3%4 3.5FALLING INTEREST RATES3200February 2001 - August 20042.5 September 2007 - March 20091502 10050FLAT INTEREST RATESMarch 2009 - December 20120.5 RISING INTEREST RATES 0 199720002003200620092012UBS Global Focus Convertible Bond Index0MSCI World Total Return Equity Index BoA-ML 1-3yr Global Investment Grade Corporate Bond Index G3 Base Rates Sources:Chart: Bloomberg, MSCI, UBS, BoA-ML, RWC. December 2012. Table: Bloomberg, MSCI, UBS, BoA-ML, RWC. December 2012.RWC | 6 8. RWC Convertible Bonds Through Business CyclesPerformance Through Business CyclesPerformance in Expansionary and Recessionary Periods300 Equities250Convertible Corporate Bonds BondsEXPANSIONARY PERIOD200January 1997 - November 200015.7%74.7%37.8%42.1%March 2009 - December 201280.0%43.0%26.9%November 2000 - August 2001-19.6%-4.6%5.0%August 2007 - March 200910049.2%August 2001 - August 200715065.8%-44.8%-24.4%-0.8%RECESSIONARY PERIOD 50 0 199720002003200620092012NBER Recession Dates UBS Global Focus Convertible Bond Index MSCI World Total Return Equity Index BoA-ML 1-3yr Global Investment Grade Corporate Bond IndexSources:Chart: Bloomberg, MSCI, UBS, BoA-ML, NBER, RWC. December 2012. Table: Bloomberg, MSCI, UBS, BoA-ML, RWC. December 2012.RWC | 7 9. RWC Convertible Bond Volatility Equity Volatility Developments70256020Performance in Different Volatility Environments50 40153010VIX AverageEquitiesConvertible BondsJanuary 1997 - January 200424.045.1%55.0%January 2004 - June 200514.712.2%1.2%June 2005 - July 200712.750.1%29.3%July 2007 - August 200823.0-15.7%-10.4%August 2008 - December 200936.4-9.5%3.5%December 2009 - December 201221.424.1%16.2%20 510 0 Jan-97Jan-00Jan-03Jan-06Jan-09Jan-12VIX (3-Month Moving Average) (LHS) Annual Volatility of VIX (3-Month Moving Average) (RHS) 70Equity Volatility and Convertible Bond Volatility60 50 40030 20 10 0 Jan-97 Jul-98 Jan-00 Jul-01 Jan-03 Jul-04 Jan-06 Jul-07 Jan-09 Jul-10 Jan-12 VIX (3-month Moving Average) Annual Volatility of UBS Global Focus Convertible Bond Index (3month Moving Average) Source: Bloomberg, MSCI, UBS, CBOE, RWC. December 2012 Table: Bloomberg, MSCI, UBS, CBOE, RWC. December 2012RWC | 8 10. RWC RWC Global Convertibles Fund Philosophy & Approach Objective:To provide long term capital appreciation through a well balanced portfolio of global convertible bonds, focusing on stock selection and disciplined management to give the optimal profile throughout the market cycle.Delta / Equity Sensitivity (disciplined portfolio construction) Balanced delta exposure of between 30 50%, focused on high convexity names (Gamma) Provide upside equity exposure with bond floor protection Global portfolio - diversified by region and sector Avoid regional delta and sectorial concentrations New issue calendar Optimum approach is index unconstrained Convertibles are issued opportunistically & fashionable sectors enjoy heavy issuance (TMT bubble, property in 2007) Equity sensitivity usually highest at equity markets peaks, and vice versa / indices can be misrepresentative Focus on high credit quality and use of internal ratings where bonds are non-rated Typically a minimum of 50% in formally rated investment grade securities High emphasis on valuing non rated securities (typically 40% of the convertible universe) Volatility Focus on cheap implied volatility within convertible bonds & low volatility of returns within fund Volatility provides diversification within a multi-asset class portfolio Little or no use of Synthetic structures Implied volatility compression / liquidity and transparency / potentially high concentration of credit risk to financial counterparties RWC | 9 11. RWC RWC Global Convertibles Delta Breakdown End of September 2013Delta Contribution by Sector Util.Delta Exposure vs. Sector vs. Sector WeightEnergy80%4.1Mat.70%3.2Cons. Stap. Health Care50%6.7 1.4 10.0Indust.30%6.1Finan.20% 7.1Cons. Disc. 4.06.08.010.070%13.030%North America24.720% 10%1.4 5.010.015.020.0Weighted Av erage Delta 51.6%South America 64.8%North America 59.4%5%8.4%Japan 56.3%25.030.0Weighted Av erage Delta 51.6%7.6%2.7%3.2%1.8%102030405060708090100Delta Contribution Range 1210.7 9.710Europe 52.4%13.1%10.3% 10%0%40%5.30.0Cons. Stap. 39%Finan. 40%50%Japan12.5%Energy 46%60%Europe16.5% 15%80%0.7South AmericaTelec. Sv c. 49%Delta Exposure vs. Region vs. Region Weight0.2Africa19.6%20% Util. 59%0%SUM = 51.66.4AustraliaIndust. 57%Mat. 59%12.0Delta Contribution by Region AsiaIT 60%10% 9.62.0Cons. Disc. 59%40%IT0.0Health Care 70%60%1.9Telec. Svc.25%90%SUM = 51.61.5Delta Distribution Range8.2 7.48Australia 44.8%6.4 6Af rica 45.5%4Asia 40.2%2 -2.73.03.00.1100.4 20304050607080901000%Source: RWC / NomuraRWC | 10 12. RWC UBS Global Focus Delta Breakdown End of September 2013Delta Exposure vs. Sector vs. Sector WeightDelta Contribution by Sector Util.80%SUM = 49.22.0Energy70%3.9Mat.3.0Cons. Stap.60%1.550%Health Care5.8Telec. Svc. IT10.9Indust.7.3Cons. Disc. 2.04.06.08.010.06.1Africa0.72.930%North America19.0South America5.020% 10%2.4 0.010.015.05.7% 3.6%4% 2% 102020.0Weighted Av erage Delta 49.2%30405060708090100Delta Contribution Range 109.4 8.79 8Europe 49.8%40%11.1% 9.8%6%South America North 68% America 57%Japan 55.1%10.7%10.4% 9.1%8%0%50% 18.0JapanEnergy 36% Weighted Av erage Delta 49.2%60%Europe10.3%Delta Exposure vs. Region vs. Region Weight 80% 70%Asia12% 10%Cons. Stap. 42%Finan. 41%Util. 46%12.0SUM = 49.20.130%Mat. 42% Telec. Sv c. 39%0%Delta Contribution by Region AustraliaIndust. 57%13.4%14%10%6.9 0.0Cons. Disc. 51%15.8%16%Health Care 57%20%6.7Finan.IT 63%40%1.3Delta Distribution Range 18%7.176.06 Af rica 43.6% Asia 31%7.25 3.74 3 2Australia 25.2%3.52.3 0.41 -0.9 1020304050607080901000%Source: RWC / UBSRWC | 11 13. RWC Example: Equinix Convertible Bonds (Aug 2010 Dec 2011 ) 1351251. EQIX shares fall by 33% after the company's lowered revenue guidance for Q3'10 and FY'10 by 2% and 1%, respectively. Our analysis led us to believe that the share price reaction was far overdone, and that our fundamental thesis remained intact. In response to the 33% decline in share price, the more conservative EQIX 2.5% convertible bonds lose only 8% of their value. The higher-delta 3% 2014 convertible bonds lose 16% of their value.3. As the EQIX share price stages a recovery, the 3% 2014 convertible bond is able to participate to a greater degree than the 2.5% 2012 bond. Over this period, the stock delivers investors a total return of 33.3% with a vol of 31.3%. The 2