Convertible Performance Across Market Environments: Implications for Insurance Portfolios
By David Tyson, Ph.D., CFA, Managing Director and Portfolio Manager; Andrew Willard, Assistant Vice President, Portfolio Management
Convertibles occupy a distinctive position between equities and fixed income. Their hybrid structure is designed to offer equity-market participation while retaining a measure of downside protection through the security’s fixed-income value.
For insurers, higher-quality convertibles may also offer capital-efficiency benefits relative to direct equity allocations. These characteristics can be particularly relevant when traditional portfolio exposures are challenged by changing market conditions. Convertibles may provide equity participation when markets are rising, potentially offer less interest-rate sensitivity than longer duration bonds when rates increase, and provide a differentiated source of resilience when stocks and bonds decline together.
This Viewpoint examines how convertibles have performed across three distinct market environments and the potential implications for insurance portfolios.
Three environments where convertibles could be helpful:
- Equity market declines: Maintain equity exposure while retaining downside protection from the fixed-income value.
- Rising interest rates: Participate in equity-market gains while potentially carrying less interest-rate sensitivity than longer-duration bonds.
- Declining stock and bond markets: Provide a differentiated return profile when traditional asset classes decline together.
Risks of Investing in Convertible Bonds
Equity market declines which reduces the value of convertibles’ equity conversion features.
A high level of corporate defaults or a sharp widening in corporate bond spreads which reduces the value of convertibles’ fixed income floors.
Low supply of issues due to prolonged low interest rates and strong demand for investment grade corporate and high yield debt.
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