“The most attractive of all in point of form”, Benjamin Graham proclaimed about convertible bonds in the 1930’s in his landmark book ‘Security Analysis’ and we can only agree. The combination of bond and equity in one single instrument makes convertible bonds an attractive asset class for most investors no matter whether you seek protected equity exposure, an enhanced yield instrument or an improved risk/reward profile of your balanced portfolio.
Sparinvest launched its global convertible bond strategy in 2016 as the first Nordic manager of convertible bonds, utilizing our long history of factor investing. The convertible bond strategy is an efficiently managed quantitative strategy seeking excess returns through active exposure to value, quality and small cap factors by investing long only in convertible bonds. Compared to the stock market, the universe of convertible bonds has a bias towards younger and smaller companies with high growth rates and limited earnings, making our strategy of value and quality uniquely diversifying in the convertible bond space.
Our research suggests that risk premia known from the equity space is also prevalent in the convertible bond space, which is not surprising since movements in the underlying equities is the main driver of return for convertible bonds in the long run. Furthermore, the hybrid nature of convertible bonds is a very strong vehicle for factor investing providing security and a floor of the bond value in times when factors are underperforming, while giving full upside potential when the factors are performing well.
Our strategy is quantitative in nature with a strong focus on diversification and risk management. With a holistic view of our portfolios, we seek to optimize our factor exposures and convexity while limiting all other risks. All companies in the convertible bond universe are subject to daily quantitative analysis using a large amount of data including default probabilities, ratings, spreads, growth rates, ESG measures, debt ratios, profitability measures, price-multiples, volatility, cash flows, in-the-money probabilities, implied volatilities and many more. The complex nature of quantitative investing and of convertible bonds in particular requires a certain human and qualitative overlay to ensure the desired qualities of the portfolios.
Some of the advantages of a quantitative process are the consistency, repetitiveness and scalability that comes with a systematic strategy that does not rely on discretionary bets that can be difficult to repeat. On the other hand, the performance of a factor-based strategy is highly dependent on the underlying factor performance, which can vary over time and underperform in longer periods. One can see the cyclicality of factor performance as part of the reason behind factor premia. To generate risk-adjusted excess return we believe a factor-based strategy provides a robust and transparent solution for the long-term investor.