Convertible Bond ETFs Offer an Alternative Way to Access Growing Companies

Companies are selling bonds that can be converted into stocks at a record pace, as more seek to capitalize on the low-rate environment. Investors can also utilize exchange traded funds to target the convertible bonds asset category.

According to Dealogic data, 97 U.S.-listed companies have issued $54.3 billion worth of convertible bonds in 2021, with nearly a third of those issuers paying nothing on interest, the Wall Street Journal reports. The amount is the highest year-to-date volume ever and 11% more than that raised for the same period in 2020, which was previously record-setting year for convertible debt issuance.

The average interest coupon on convertible debt so far this year was 1.41%, the lowest on record. The recent issuers will only need to convert their bonds into stock if share prices increase 39% within a five-year period, the highest so-called conversion premium since 2003, according to Dealogic.

“These are the best terms in the history of the market,” Vijay Culas, the founder and chief executive officer of Matthews South, told the WSJ. “We’ve never seen anything like this.”

Market observers attributed the accelerating pace of issuance to inflation fears and the potential for rising interest rates. Meanwhile, the issuance this year reflects optimism among the companies’ outlook on their business prospects and the future of the stock market.

Even if rates rise down the line, industry observers believe that companies, including those pursuing direct listings, will continue to dabble in the convertible bond market as an alternative for investors seeking another way to access growing companies.

“There’s a broad buyer base that will keep things busy and a more diversified universe of issuer clients,” Serkan Savasoglu, a managing director and head of global equity solutions at Morgan Stanley, told the WSJ.

Investors can capture bond exposure with assets like the American Century Quality Convertible Securities ETF (QCON), which is an actively managed convertible bond portfolio that focuses on quality, industry diversification, and balancing beta exposure to optimize risk/return potential for investors seeking a diversifying alternative strategy.

The American Century Quality Convertible Securities ETF overweights issuers with a stronger earnings profile, stronger balance sheets, and higher-than-average credit ratings; targets a more balanced beta range for the portfolio to mitigate sharp price declines; and aims to diversify across industries and sectors to address benchmark concentration.

QCON’s bond-like convertibles segment eliminates issuers with highest default risk and optimizes issuers based on valuation and yield. The ETF’s equity-like convertibles portion eliminates issuers with lowest profitability and lowest realized growth, instead optimizing issuers based on profitability and growth. The portfolio then seeks the securities with the best structural features, accounting for market inefficiencies that may impact relative valuation among issues. Lastly, it ensures alignment with aggregate portfolio risk/return objectives, liquidity, and portfolio constraints.

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