Generating returns and managing volatility: the absolute return approach to convertible bonds (October 2016)

Current market uncertainties offer a very attractive entry point for convertible bonds which carry an appealing optionality. In more general terms the asset class offers above average equity-like returns, downside protection and limited volatility.

It is characterised by an attractive asymmetry which offers correlation to equity markets in bullish market conditions and downside protection in falling equity markets, therefore benefitting from a self-adjusting, risk-adjusted return profile. Numerous studies show that the asset class has outperformed equities or other more traditional strategies over the long-term with lower volatility (source: Exane as of end of August 2016).

In fact, as of late the asset classes’ valuations were supported by beginning of the year outflows following a risk-off mode and a decline of underlying equities. From a valuation point of view, convertible bond implied volatilities lost on average more than 5% YTD and even 10% since mid-November and just started to rebound after having reached multi years’ lows.

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