Rates rise, convertibles do what?

David King, CFA, Senior Portfolio Manager | August 9, 2013

  • There is a very common concern that convertible securities will not perform well in a rising interest rate environment.
  • Analysis of past rising rate periods shows that convertible returns have been neutral or positive as long as stock returns were positive.
  • Accordingly, we do not see concern about rising interest rates alone as a good reason to avoid convertible securities.

There is a very common concern that convertible securities will not perform well in a rising interest rate environment. Other asset managers have written on this topic recently, and since we are all looking at similar historical data and characteristics, the conclusion of these pieces has been consistent. Rather than reiterate many points made by others, here is my attempt to write the shortest possible article on this topic:

  • Over the last 20 years, there have been five periods of time when intermediate interest rates (as measured by five-year Treasury Notes) rose by 100 basis points or more.
  • In these periods, convertible securities had a negative return only when equities also lost money. Convertible returns were neutral or positive as long as stock returns were positive.*
  • While it is difficult to measure, the option-adjusted duration of the convertible market is low, similar to that of a short-duration bond fund.** Re-allocating bond exposure to convertibles will tend to shift risk away from interest rates and toward equity risk factors like growth and profit margin potential.
  • Since the end of April, the interest rate on five-year Treasuries has increased almost enough to qualify for this analysis. Broad equity market returns are positive over this timeframe, as are convertible benchmark returns.

Based on these observations, we do not see concern about rising interest rates alone as a good reason to avoid convertible securities.

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*Data provided by Bank of America/Merrill Lynch

** Calculations provided by Barclays and Bank of America/Merrill Lynch

 

David King

CFA, Senior Portfolio Manager
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