Asian investors not yet converted

The following story appeared in the March 2010 edition of AsianInvestor magazine. Paid subscribers can access this and other magazine stories here. For subscription enquiries, please contact our subscriptions team or call +852 2122 5222.

Fund managers are finding Asia fertile ground for sourcing convertible-bond investments, but inflows from investors new to the asset class – particularly within the region – are still proving elusive. This is despite a 39% return from the UBS Emerging-Market CB Index for 2009, compared to the 22% gain posted by the UBS global CB benchmark. Of course, these figures followed a big drop in performance in late 2008.

There is clear optimism for the region's convertibles market for the coming months, in view of recent fund launches, an anticipated high level of volatility in 2010 and a healthy pipeline of potential issues. Bankers hope the growing sophistication of Asian investors will ultimately result in substantial inflows into the asset class, although direct CB investment is likely to remain a market for professionals, given the level of expertise required.

Convertible bonds do call for more sophistication and experience than equities or vanilla fixed income, which few Asian investors have. It is well known that CBs provide the security of a bond with the upside of stocks, but it is a complex instrument.

A CB is a bond that can be converted into a pre-determined amount of the company's equity at certain times during its life through a stock option embedded in the contract. The greater the volatility in equity markets, the higher the value of a CB's embedded stock option. This makes CBs tools for arbitraging volatility, by pairing the purchase of convertible bonds with the short sale of the same issuer's common stock. Many hedge funds are dedicated to trading CBs in order to exploit the cheap volatility offered by the equity option.

In Asia, the investor base for long-only holdings of CBs, looking for generic instruments with equity returns and bond-like characteristics, is underdeveloped. This has skewed the local marketplace toward the traders, but a slew of new funds is now being packaged with long-only institutional investors in mind.

Paris-based Edmond de Rothschild Asset Management is marketing a new emerging-markets CB fund that will source at least 70% of its investments from...

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