Ideas in action – Equity style divergence driving US convertible bonds performance

May 10, 2023

The divergence in style and sector performance in US equities continues to be a key driver of short-term performance for convertible bonds.

In the last week of April alone, US mega caps outperformed the average US convertible bond underlying equity by more than 4%.

This unusually narrow leadership in US equities makes us cautious in the short term on US headline indexes performance. On the positive side, we start seeing value appearing in US convertible bond issuers, especially as the earnings season has so far shown improving fundamental dynamics, especially in tech-related sectors.

Recent performance of US equity indexes

Recent performance of US equity indexes graph

Source: Bloomberg, RBC BlueBay Asset Management. Daily data to 28 April 2023. Indexes used: S&P500 equally weighted, CRSP US Mega Cap Index, Bloomberg US convertibles underlyings and Russell 2000.

Outlook

The positive view we hold for convertible bonds over the medium term is predicated on a higher volatility regime. It was therefore frustrating to see such low levels of realised and option-implied volatility in April. However, we remain convinced that macro uncertainty, driving the current high volatility levels in interest rates, will eventually feed through higher equity volatility and a stronger appetite for convertibles. We are encouraged by the fact that both primary market trends and liquidity conditions are painting an improving picture for convertible bonds.

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