Saul: convertibles could spread as schemes look to reduce volatility

Schemes are exploring ways to reduce volatility in their portfolios following strong equity performance over the past year, including using strategies such as multi-asset investing, smart beta or by investing in illiquid assets. 

Given that we’re all looking for low-volatility equities and converts enable you to deliver that, then I think there will be increasing interest

Penny Green, Saul

Convertible bonds are debt instruments that can be converted into equities at any time, a characteristic proponents argue could help lower schemes’ vulnerability to rising interest rates as convertibles are less sensitive to rate moves compared with that of gilts and traditional bond investments. 

Penny Green, the Superannuation Arrangements of the University of London's outgoing chief, said that as well as the ability to dampen down volatility, convertibles give investment managers the flexibility to invest across the capital structure. 

She said: “You like the company, but maybe you don’t like the equity, because of what equity markets are doing. So take the convertible, which gives you the opportunity to either invest in the credit or to invest in the equity.” 

Saul invested around a total of 3 per cent of its portfolio to three global emerging markets managers in 2011 totalling around £50m, with one of those managers specialising in convertible bonds. The allocation was made from Saul’s growth portfolio due to the bonds’ “equity-like characteristics”, said Green. 

But Chris Redmond, global head of fixed income manager research at consultancy Towers Watson, said that while there are some strategic diversification benefits to the asset, the underlying investment characteristics can be replicated using a combination of corporate bonds and equities. 

“Consequently, we see the relative weights of the additional governance associated with a dedicated allocation to convertible bonds and the marginal contribution to portfolio risk-return characteristics to be quite finely balanced,” he said. 

John Arthur, managing director at AllenbridgeEpic Investment Advisers, said they had not seen many schemes with specific convertible bond portfolios, even among larger funds, but “more often, convertibles are allowed within other mandates, so for an equity mandate they can be used defensibly”. 

He added: “But the manager and client need to agree why and in what circumstances they would be used.” 

Preaching to the unconverted 

Green said that while it is still “early days”, the scheme was happy with the performance of the strategy to date, adding that she expected to see greater appetite among other schemes. 

She said: “Looking at an equity manager over five years is possibly too short a timeframe and three years certainly is. But certainly the evidence to date is [that] it is delivering exactly what we expected it to.”   

Green added: “Given that we’re all looking for low-volatility equities and converts enable you to deliver that, then I think there will be increasing interest.” 

However, the niche nature of convertibles meant the pool of investable assets could remain small, she said. The global convertibles market is an estimated $363bn (£219bn), according to John Calamos, chief executive officer and global co-chief investment officer of fund management company Calamos, which invests in the asset class. 

“Issuers are usually smaller, growth companies with lower credit ratings that are trying to reduce their borrowing costs by offering the equity kicker as part of their debt,” he said. 

Green said: “The problem is it’s not the world’s biggest market, not every company issues convertibles. So it’s not going to be as mainstream as everyone investing in UK equities, for example.”