Convertible securities have not been immune from the volatility that has roiled risk assets in 2016. However, we believe the volatile start to the year has set the stage for longer-term opportunities. A convertible bond can be thought of as a corporate bond (credit) with an embedded call option (equity). (For a primer on convertible valuation, please see our guide.) Because of its stock and bond characteristics, a convertible’s valuation can be influenced by forces in both the credit and equity markets, as well as by dynamics that are specific to the convertible market.
In this post, we’ll take a look at some factors that we believe can support convertibles going forward. More specifically, credit spreads have widened dramatically, equities have declined significantly, and convertible valuations have cheapened. A reversal in any one of these factors could provide a tailwind to convertibles, and if all three reverse, convertibles may be poised for a potentially powerful “trifecta.”
