Ideas in action – Convertible bonds have limited exposure to the banking sector

Apr 11, 2023

Convertible bonds are mostly senior instruments with no preferential bank capital treatment, but they have an equity dilutive component.

This explains why banks rarely issue convertible bonds: it would have a direct negative impact on their Return on Equity (RoE). For full clarity, bank capital instruments such as “CoCos” are out of scope for the convertible bond strategy.

As shown in the chart below, the banking crisis triggered an aggressive sector rotation. Bank stocks were logically under pressure whereas large cap tech stocks were seen as a safe haven. This price action suggests that the big de-rating in tech stocks happened in 2022 and is now largely behind us. Companies issuing convertible bonds saw some moderate weakness in their stock price. Going forward, we think the limited direct exposure to the banking sector and the bias towards secular growth should help convertible bonds, as it gives them a defensive edge in periods of risk aversion.

Recent performance of US equity indices

Recent performance of US equity indices chart

Source: Bloomberg, RBC BlueBay Asset Management. Daily data to 31 March 2023. Indices used: S&P 900 Banks, Nasdaq 100, Bloomberg US convertibles underlyings.

Outlook

The banking crisis only added another layer to an already highly uncertain macro outlook. We re-iterate our view that investors need to prepare for a more volatile environment in the coming months, if not years. This volatility can clearly be seen in rate markets, and we think equities will follow. Convertibles, with their short-duration characteristics and natural positive bias for high volatility, should help investors navigate the current environment.

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