It is interesting to analyze the situation of the different sectors, because the divergences are particularly pronounced there.
“Each crisis is also an opportunity”: this sentence resonates like a platitude, probably rightly, for investors faced with significant losses since the beginning of the year. Because of course, things are not so simple: for investors, the challenge is to recognize this opportunity and know how to seize it. In our view, there may be such a chance right now in the wake of the collapse in growth stocks. Indeed, equity valuations in sectors such as software and e-commerce have deflated significantly and are now at very low levels. These are often well-established and profitable companies, therefore very different from the hopeful and loss-making profiles that characterized the Internet bubble. Of course, the question of when to invest remains crucial, because a new correction cannot be ruled out. It is precisely here that convertible bonds can represent a sensible alternative to equities. Indeed, a correction does not affect their valuations in the same way. In this way, the correction phenomenon modifies the very structure of convertible bonds (namely their sensitivity to equities) to the benefit of investors.
Many convertible bonds currently offer ideal conditions in terms of convexity
A comparison between June 2022 and the market a year earlier highlights the change: the equity sensitivity of the global universe of liquid convertible bonds, measured by the Refinitiv Global Vanilla index, stood at the end of June at 33%, compared to 55% a year ago. In other words, a large number of convertible bonds that previously behaved to a large extent like equities are now in the inflection zone of their convexity. Convertible bonds have a very advantageous asymmetric risk/opportunity profile, which allows them to absorb rising equity prices in greater proportions than corrections. In addition, a considerable number of convertible securities are now in the zone where their characteristics approach those of bonds. Depending on their risk tolerance and assessment of the market, investors may choose to adopt a more defensive positioning again if they wish. Future increases will take place from very weakened price levels, while at the same time these securities offer much more effective protection against declines if it turns out that the correction is not over.
Growth stocks with a parachute
It is interesting to analyze the situation of the different sectors, because the divergences are particularly pronounced there. The cyclical activities of consumer goods, information technologies and communication services should be particularly penalized by the correction. Consequently, these are also the stocks that have experienced the largest variations in their sensitivity to equities. In these three sectors, the average levels of equity sensitivity fell from 62%, 61% and 64% respectively to 31%, 35% and 34% in the space of a year, almost halving. From where the possibility of acquiring titles, in particular of growth, which are almost accompanied by a parachute. In recent years, these securities very often tended to behave more like equities shortly after their issuance and thus lost their attractiveness in the eyes of investors in convertible bonds, because their convexity characteristics were considerably reduced.
Chart: Change in equity sensitivity across selected sectors
Recovery in demand for protection solutions against cyberattacks
Cybersecurity is one of the examples of structurally promising themes within the digital transformation megatrend. Relevant studies show that the demand for IT security goods and services should experience sustained growth: this is due, on the one hand, to the acceleration of digitalization favored by the pandemic at all levels, both among administrations and authorities than within SMEs. The development of networks also increases the number of potential security breaches and “gateways” to cyberattacks. On the other hand, there is a political and geostrategic component that has become much more sensitive since the start of the conflict in Ukraine. Investors can participate in the success of companies in this sector through convertible bonds. The potential of this investment theme is further evidenced by recent mergers and acquisitions that have taken place in the sector, often takeovers of specialist companies by large technology groups. For example, Thoma Bravo acquired Proofpoint, McAfee sold its B2B business to Symphony, and Google’s parent company, Alphabet, acquired Mandiant (formerly FireEye).
We also identify some opportunities in the other two sectors that have been hurt by the markets, namely consumer discretionary and communication services, but in this respect, the uncertain economic environment, marked by fears of recession, inflation and the rise in interest rates, encourages us to be more cautious. This is particularly the case in the field of transport, to which cruise passengers and air carriers belong. Overall, in view of the current environment, marked by both opportunities and some serious risks, convertible bonds represent an attractive investment opportunity, thanks to their asymmetrical profile.
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