Ideas in action – Bond-equity correlation’s recent shift is supportive for convertibles

Jun 09, 2023

One of the most striking features of financial markets in 2022 was that both bonds and equities had negative performance at the same time. In the past few weeks, the price action suggests that this historically rare period of positive correlation might be over. Markets seem to be back to a pattern whereby strong economic data can drive bonds lower and equity markets higher.

We see this as a positive development for convertibles as it enhances the diversification benefits of the asset class. As the bond and equity components of convertibles balance each other, it could make the asset class more “convex”: a bit more upside capture and a bit less downside risk.

Nasdaq-observed duration versus US 10-year rate (rolling 60-day window)

Nasdaq-observed duration versus US 10-year rate (rolling 60-day window) chartSource: Bloomberg, RBC BlueBay Asset Management. Daily data to 31 May 2023. Indexes used: Nasdaq 100 (NDX) and generic US 10-year treasury yield.

Outlook

At a time of high uncertainty, financial markets seem to be more driven by short-term flows and technical positioning than fundamentals. This contributes to widening the dispersion in asset performance. The market environment is hard to navigate for investors, and we feel the need for risk mitigation and portfolio diversification has never been greater. Convertible bonds are the type of asset class that can help achieve these objectives. The positive performance seen in May should help convince investors of the benefits of the asset class.

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