What do Elon Musk of Tesla, Charlie Ergen of Dish Network and Jack Dorsey of Square have in common?
Their companies all sold convertible bonds in the first three months of 2017, helping make it a bumper quarter for issuance of this kind of hybrid security. In all, 34 US companies tapped the market, the most since 2014, raising $11.1bn, according to Dealogic. With equity valuations running hot, that trend looks set to continue.
Convertible bonds are a sweet spot where both issuers and investors can do well. While the Trump administration’s difficulty marshalling its agenda has knocked a little of the complacency out of the equity market as the second quarter opens, investors in convertibles might find that only adds another source of returns.
Unlike typical bonds, convertibles include an option to convert the investment into shares at maturity, instead of just getting the cash back. That gives investors a lot of the upside of a company’s share price, but with the safety of knowing they get their principal back in cash if the stock tanks, plus interest in the meantime.
Over the long-run, convertibles have tended to capture close to 90 per cent of the upside from an equity market rally, without going down nearly as much in bear markets. That has held true so far this year: first quarter returns of 5.3 per cent on the Merrill Lynch US convertibles index came close to the 6.1 per cent returned by the S&P 500.
Technology companies are among the most enthusiastic issuers of convertibles, in part reflecting the volatility of their shares. The more volatile a stock is, the more valuable is the option to buy it. All else being equal, if uncertainty around the political situation in the US leads to more market volatility generally, that should make convertible bonds more valuable, too.
And this should also encourage more issuance, says Hart Woodson, portfolio manager at Advent Capital, since convertibles offer companies a way to “monetise that volatility”.
Tesla raised almost $1bn in convertible bonds last month to fund production of its new Model 3, while Dish tapped the market for $1bn and Square for $350m. There will be more to follow.
Sample the FT’s top stories for a week
You select the topic, we deliver the news.