Performance
Despite a few ups and downs, the first six months of 2025 have been a very good period for the U.S Convertible market. Year-to-date the ICE BofA U.S. Convertible Index is up 6.55%, slightly ahead of the S&P 500’s 6.20% advance and the NASDAQ’s 5.86% gain. Despite the presence of many small and mid cap companies in the U.S. convertible market, the asset class has not been dragged down by the performance of the small cap Russell 2000 Index which is actually down 1.80% year-to-date. The solid performance of convertible securities relative to stocks has been helped a bit by the mixed performance of the so-called Magnificent Seven. While Meta, Nvidia, and Microsoft are up by 26.26%, 17.66%, and 18.46%, respectively year-to- date, Tesla and Apple are down 21.34% and 17.88% respectively. None of these mega-cap tech companies are in the U.S. convertible Index. In addition, several large constituents in the U.S convertible universe within the Information Technology sector have recorded large year-to-date gains.
While the convertible market’s recent gain has been impressive, convertibles were also able to hold up well versus equities during the equity market swoon in early April. The S&P 500 was down 13.63% at the close of April 7th 2025, the market’s’ low point for the year. On that same day, the U.S. Convertible Index was down just 6.60%, for a downside capture of just under 50%. Much of the convertible market’s strong showing can be attributed to the fact that entering the year, the average bond price in the Index was just above par or $100. When equites headed lower, convertibles held up relatively well given their relatively short maturities, whereby, barring bankruptcy, in a few years time, investors would have their bonds redeemed for $100 at maturity, a price not very different from where most bonds were trading in the market. That convertibles have been able to outperform equities in both up and down markets this year is testimony to the unique nature of the asset class - it’s asymmetric return profile - the ability to participate in the upside of stocks, but also provide some measure of managing downside risk when equities decline.
*(performance data from Bloomberg)
Issuance
Through the end of the second quarter of 2025, new issuance totaled $48.3 billion, (from Bank of America data) ahead of last year’s $40 billion of new issuance for the same period. While issuance declined to a trickle during the market selloff in April and early May, June alone saw $17.6 billion of new issuance come to market once equity prices stabilized. New issuance has come from a variety of sectors and market caps. Many companies are eager to raise low-cost capital in the convertible market to refinance higher cost debt or use the proceeds to expand operations. We purchased several new issue offerings as we believed that these companies have solid underlying businesses, strong prospects for growth, and reasonable valuations based on prospective free cash flow estimates. We expect new issuance to continue at a healthy clip as many companies that issued debt during the pandemic need to refinance the upcoming maturities. In addition, many companies that were used to borrowing at very low rates in year’s past will find the convertible market an attractive source of low-coupon debt financing.
Positioning and Outlook
With the equity and equity-linked convertible market at all-time highs, the sharp decline tied to the imposition of steep trade tariffs just three months ago seems like a distant memory. Since then, the markets have shrugged off geopolitical tensions and seemingly every market drop is seen as an opportunity to buy the dip. With equity valuations higher than they were at the end of last quarter, we are more concerned about investor complacency than a fear of missing out. We maintain a measured and agnostic stance on broad market direction, focusing instead on valuation discipline and quality fundamentals. We are not incorporating any macro-economic view into our investment decisions, as our investment process is focused on company-specific fundamentals. Our largest exposure is the Information Technology sector which also has the largest representation in the U.S. convertible universe. We are relatively in-line with the benchmark’s 29% weighting to that sector. We continue to believe that our process, which emphasizes strong company fundamentals and reasonable valuation, will outperform over a complete market or economic cycle.
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