A Crop of New Convertibles
An asset class comes back from the dead.
Oooohh, it has to be for you to grow...
30 years ago, Roger Hodgson of Supertramp was singing about finding meaning and happiness amid some kind of mid-life crisis in "Take the Long Way Home." But he might as well have been talking about the events of the last 12 months in the convertible bond market.
As I drove to my office this morning and listened to the statistics on recent new issuances, I was struck that convertible bonds were mentioned before equities, even though the size was substantially smaller.
Last year, convertibles collapsed, even by the standards of 2008's general destruction. Hedge funds came unglued, done in by the 3-headed monster of leverage, credit deterioration, and ridiculous government policies against hedging via short-selling
But this year the asset class is back from the dead, arguably on far healthier footing after its catastrophe. Owned far less by hedge funds and far more by long-only investors, convertibles are once again becoming legitimate financing tools while giving investors superior risk-reward exposure to stocks.
Noteworthy home runs among household names in this year's crop of new convertibles include Newell Rubbermaid's (NWL) 5.5% bonds, which soared above 150% of par in the aftermath of its March issuance, and Alcoa's (AA) 5.25% issue, which recently changed hands near 190%. Both of these issues, of course, benefited greatly from big subsequent rallies in the underlying stock. But unlike the stock, you knew when you bought these issues that the worst you would do (excepting bankruptcy) was to get your money back in 5 years. Pretty nice upside with that kind of floor underneath you.
The main stumbling blocks remain the 2 Es: education and execution. Investors need to be educated better about this generally superior alternative to their current asset mix. Brokers need to do a much, much better job of making the securities available to their customers through painless transactions.
The world of finance has been taken down quite a few pegs over the past year. Last week, while visiting my father in North Carolina, I listened to one of his poker buddies tell me how: "The problem with you guys is, you don't make anything."
Understandable. But if we do our jobs right, we do make it possible for others who do make things to have access to tools and resources they might not otherwise have.
Investors want income and upside. The perils of stocks (wild, unpredictable valuation swings with no guaranteed exit price) and bonds (exposed to inflation) on their own suggest investors deserve to be better educated about a security that frequently offers a better mix of upside possibility and downside protection. For too long, a mix of greed and inertia has stood in the way.
I hope more people will hear about the success of convertibles in the new-issue market this year and start asking the right questions.
Ultimately, economics is about scarcity. We win as individuals and as a society when we allocate resources to their best uses. That's why I joined Minyanville, to help in the process. I may not be making anything, but I think I'm doing my part.
Please keep an eye out for my book, The Undoing of Cowardice, coming later this summer.
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