By Goldman Sachs Global Convertible Research (Scott Lange, Dan Sommers, Chip Seidler, et al.); March 6, 2001

A paper by Goldman Sachs summarizes Ibbotson Associates ' study and comes to the conclusion: Convertibles remain compelling in delivering returns that approach those of equities with much less volatility.

Conclusions

• Convertibles continue to exhibit solid risk-adjusted returns

Updated Ibbotson analysis demonstrates that convertibles remain compelling in delivering returns that approach those of equities with much less volatility.

• Convertibles continue to present a compelling risk/reward profile

Over the long term, convertibles have delivered 70% upside participation with equities and only 52% of the downside.

• Sustainable drivers are in place for continued strong long-run performance

Convertibles typically appear underpriced at issue, and we expect the unwinding of this undervaluation to continue to serve as a driver of strong long-term performance. Inefficient callability, whereby issuers rarely call their convertibles at the optimum moment, further enhances long-run performance relative to theoretical expectations.

• New issuance in 2000 enjoyed explosive growth from 1999's record levels

Despite difficult conditions in the US financial markets, US convertible issuance reached $61.3 billion in 2000, up a remarkable 50% from the previous year’s record total. As we begin 2001, early indications point to a continuation of the strong new-issue calendar, with a bias toward investment-grade issuers.

• Convertibles can optimize performance in fixed-income as well as equity portfolios

Convertible performance has been highly correlated with both large- and small-cap stocks, but much less correlated with the various fixed-income asset classes. This implies convertibles will provide particularly effective diversification in fixed-income-oriented portfolios.

Compelling long-term convertible performance

We summarize below some of our findings based on extensive research conducted by Ibbotson Associates in association with Goldman Sachs over the past several years.

• Over the period for which reliable long-run data are available (i.e., since the early 1970s), the total return performance of the U.S. convertible market has approached that of the S&P; 500 with significantly lower risk. Over this same period, convertibles have significantly outperformed long-term corporate bonds while showing comparable risk.
• The total returns for convertible bonds have demonstrated a much higher correlation with the S&P; 500 than with the corporate bond universe.
• Convertibles are useful in optimizing performance in both fixed-income and equity portfolios.

Sustainable rationale for outperformance

We highlight three possible reasons for this apparent long-run outperformance of convertible instruments:

• Attractive convertible pricing at issue,
• Ostensibly inefficient company timing in calling convertible instruments, and
• Exposure to a universe of significantly higher-beta underlying stocks (than the S&P; 500) through a period of long-run excess returns from equities.

Importantly, we believe that the first two reasons in particular are sustainable going forward, with clear positive implications for the future performance of the convertible asset class.

See also

• Convertible Bonds as an Asset Class: 1957-1992
• Convertibles as an Asset Class - 2001 Update
• Convertibles as an Asset Class - 2002 Update