Investors are facing a barrage of uncertainties all at once. First, Russia’s invasion of Ukraine will have wide-ranging geostrategic and economic repercussions, even if a swift resolution is reached. Long-held market assumptions, such as ever-advancing globalisation, were previously cast into doubt by the Covid crisis and are now being challenged openly. Second, stubbornly high inflation, combined with rising interest rates, is requiring a readjustment of investors’ portfolios. While geopolitics could well postpone the expected tightening in monetary policy, it is unlikely to cause central bankers to reverse their policy trajectory.
Such an uncertain, and therefore volatile, market environment plays to the strengths of convertible bonds. Their unique ability to track rising equity markets higher, while providing downside insulation in bearish conditions has been demonstrated year to date. Convertibles have so far given up far less ground on average compared to equities . And if a rally does occur, convertibles should be able to recoup their losses faster from a higher starting point. We are currently overweighting those sectors we believe will play a key role in helping society adjust to the return of a bipolar world.
Energy – renewables and fossil – remains a key theme
Energy will be an important theme for the coming years, as Europe recognises the risk of its dependence on Russian oil, coal and natural gas supplies. To wean itself off that risk, it will have to replace Russian supplies in the short and medium term. This should benefit both non-Russian oil companies and US shale gas companies. Wind and solar energy suppliers are also likely to benefit from the expected heavy investments in the energy sector, as will manufacturers of key components of the power grid, such as cables. Higher oil prices and government incentives could also make e-mobility a reality on a large scale much sooner than expected. Big players in this space would be power grid operators, battery technology companies and makers of electric vehicles. As the CB universe features a disproportionately large number of growth companies, it offers attractive investment opportunities in all of these areas.
Geopolitics has brought cybersecurity into focus
The previously obscure world of cyberwarfare has been thrust into the spotlight in recent weeks. State-sponsored agencies and “hacktivist” groups are trying to win the information war and disrupt the operations of other parties. The crucial role played by cybersecurity companies in protecting businesses and government institutions from attacks and disruptions is now clearer than ever. Accordingly, it is gaining importance in investments, including in the convertible bond asset class. More generally, companies with strong competitive positions, solid balance sheets, high profit margins and inelastic supply-and-demand dynamics are the top choices for CB portfolios. We expect them to be better able to cope with higher input costs and rising inflation.
Timing one’s initial or subsequent investments is one of the major fundamental challenges facing investors. Again, convertible bonds are a good choice for having a foot in the door of a recovery. And CBs’ built-in parachute offers a buffer if a market correction does occur. Looking back, convertible bonds have shown over the past 25 years that they can enhance the stability of an equity or composite equity/bond portfolio without the investor having to settle for noticeably lower returns over an equity market cycle.