EdR AM expects continued boom in convertible bonds

May 8, 2011

Fast-growing firms in Asia have stepped up issuance of convertible bonds, which often perform well in a rising interest-rate environment, notes Edmond de Rothschild AM.

The boom in convertible bond issuance in Asia is tipped to continue, with investor demand likely to remain strong amid forecasts of interest-rate rises in the region to counter inflationary pressures.

Asia-Pacific is fast increasing its share of the world’s convertible bond market. With $164 billion in outstanding convertibles, it accounts for 21% of the universe by value versus 61% for the US and 18% for Europe, finds data provider Dealogic. Ten years ago it was just 5-10%, by estimates.

The region has seen a sharp rise in convertible bond issuance over the past few years. Asia-Pacific accounted for 21% by value in 2008, 25% in 2009, 36% in 2010 and 38% this year-to-date, finds Dealogic.

The number of jumbo deals from the region is also growing, including a $1.8 billion convertible bond by a unit of China Unicom (HK) last September, a $1.1 billion dual tranche deal by Big Will Investments last month and a $1 billion issue from Hon Hai Precision last October.

“What we have seen over the last six months of 2010 and this year to date is intense issuance out of Asia,” confirms Kris Deblander, deputy director and head of convertible bonds at Edmond de Rothschild Asset Management.

“It makes sense. A convertible bond is an instrument that is ideal to fund growth, and growth today is coming more from developing rather than developed economies.

“Plus investors' risk appetite is shifting more towards these markets. If you wanted to place a $1.5 billion convertible bond deal in Europe these days you might be struggling, but if you do it in Asia on interesting terms, it goes very fast.”

China continues to dominate new convertible bond issuance in Asia, accounting for 44% by value in 2010, followed by Taiwan (14.5%), Japan (13.3%) and Hong Kong (8.4%).

Amid a frantic hunt for yield in a low interest-rate environment, the number of high-yield convertible bonds issued out of Asia is also rising, and attracting global attention. Six of the 10 largest deals from Asia so far this year have been high yield.

Edmond de Rothschild fund manager Nicolas Schrameck notes that convertible bonds offer diversification in a fixed income portfolio and tend to have very low sensitivity to interest-rate rises because of the conversion option, which he sees as an appealing factor to investors in a region where inflation is a widespread challenge.

Beijing has already raised interest rates 100 basis points (bp) in the past six months, and even though it is likely coming to the end of its tightening cycle, a further hike is expected with inflation well above its annual 4% target.

Meanwhile, this month the Reserve Bank of India hiked the repurchase rate 50bp to 7.25%, with a further 75 percentage point rise to 8% expected by HSBC this year to counter inflation, which averaged 9.5% last year.

“In years where you see interest rate hikes, convertibles tend to perform really well because typically markets and commodity prices get inflated and Asian companies in general are more exposed to commodities,” says Schrameck.

“We expect this trend [of increased Asian CB issuance and jumbo deals] to continue. We should see at least 30% of new issuance coming from developing markets. With interest rates increasing, convertible bonds should be the most favoured debt instrument.”