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Inflation shield? Traders are now looking at convertible bonds

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In 2022, inflation will most likely be at the top of concerns in the financial markets. How do you go about protecting your wallet? Traders are now looking at convertible bonds which they consider to be well positioned relative to other asset classes. “In an environment of rising rates, these instruments have historically performed well due to their shorter effective duration than other fixed income instruments,” explains Renaud Martin, Co-Head of the Convertible Bonds team at Mirabaud Asset Management.

The expert expects that in such an environment the primary market will remain a favorable ground, as issuers of convertible bonds generally sell bonds at lower coupon rates than traditional bonds, thanks to their own conversion option. In particular, issuers from the “old economy”, active in sectors such as energy, mining and basic industrials, with broad access to the traditional bond market, may return to the convertible bond market to take advantage of lower costs.

Knowing how to choose the right styles and sector exposures will be key. “We tend to favor issuers in cyclical sectors, such as small and mid caps, which should benefit from the reflation trade, rather than high growth companies whose underlying equity performance is vulnerable to rising rates and inflation. – says the expert -. In the last two years, the large availability of new issues has allowed us to have a wide and renewed offer of opportunities, including those securities that benefit from an inflationary environment ».

The health situation and the emergence of new variants could delay the realization of this scenario, as central banks could be tempted to slow down the pace of tapering. Convertible bonds remain well positioned, as deals recorded in high-growth sectors such as food delivery, online retail sales or payments, among others, could help in going down what may prove to be a path. bumpy “says Renaud Martin who then adds:” We expect the reflation “winners” – including commodities, cyclicals and small caps – will continue to outperform in 2022 as well and we think that globally there are unique opportunities on the base of interesting prices and positioning ».

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Among the stocks that the expert mentions in the United States are a number of not overly expensive companies with upside potential such as Coinbase, The RealReal or Zynga. Convertible bonds from issuers popular with retail investors, such as Dish Network, Twitter, Teladoc Health or Chegg. China‘s convertible bonds are still attractively valued in light of the Communist Party’s regulatory crackdown – examples are Tencent, China Education, or Postal Savings Bank of China. While they generally trade at a premium, some ESG-friendly borrower stocks are relatively cheap. “As examples we could cite the green offers from renewable energy producer Neoen, electric vehicle manufacturer Fisker and Swiss photovoltaic manufacturer Meyer Burger,” he says.

Rocco Bove, Head of Fixed Income at Kairos also looks to convertible bonds, who mentions these instruments in the Outlook on the first quarter of 2022. “At the corporate level, selectivity will return to the core because the surge in the price of raw materials risks depressing the profitability of some player and, even in a benevolent context from the point of view of turnover growth, there is a risk of some idiosyncratic accident in some market segments such as high yield – explains the expert -. Still a positive view on financials, convertibles and inflation-linked securities. Attention not only to the level of rates, but also and above all to the slope of the curves: an excessive flattening can generate an increase in the risk premium even on instruments far from the bonds; never as on this occasion, form is also substance ».

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