Merrill convertible analyst: Convertible returns up 24% in 2003 - the biggest gain since 1999

By Ronda Fears

Nashville, Jan. 2 - Convertible players in 2003 could have partied like it was 1999. That is because the market saw its biggest gain, 23.9%, since 1999 as stocks led by technology and speculative-grade issuers took off, according to Merrill Lynch & Co. Inc. convertible analyst Marc Malloy.

The Nasdaq, propelled by the rebound in the technology sector, led all benchmarks with a hefty 50.8% annual gain. The S&P 500 and the Dow Jones Industrials both had impressive returns during the quarter, bringing annual increases to 28.7% and 28.3%, respectively.

Not unsurprising, high-yield names outperformed high grades, which led to a preference for small cap convertibles, tech issues and a focus on the growth strategy.

Because of the spike in stocks, though, equity alternatives dominated market performance.

The equity alternatives convertible index, issues with a delta of 0.8 and above, gained 48.34% for the year. Comparatively, total return alternatives - with a delta between 0.8 and 0.4 - rose 33% in 2003, and yield alternatives - with a weighted average delta of 0.17 - gained 21.62% for the year.

Speculative-grade convertibles soundly outperformed their investment-grade counterparts. For the year, speculative grades rose 42% while investment grades picked up 14.51%.

This trend was mirrored in the straight bond universe as speculative-grade credits outperformed investment-grade credits. The Merrill high-yield U.S. corporate index increased 27.23% for the year, while its corporate master index gained only 8.31%.

Thus, investors continued to exhibit a preference for small cap convertibles, because of the superior yield.

In 2003, the small cap convertible index, which had a weighted average current yield of 4.4% at year-end, was up 36.8% as underlying equities gained 54.5%. Mid caps, 61% of which were speculative-grade issues, appreciated 32.7% during the year with those stocks up 69.2%. Large caps, which had a delta of 0.44 at year-end, lagged with a 22.5% gain for the year as the equities rose 53.2%.

Technology convertibles were the biggest contributors to the U.S. convertibles index in 2003. Led by the communication equipment industry, which was up 78.3%, and the internet software and services industry, which was up 53.1%, the tech index gained 42.5% during the year as those stocks soared 102.2%.

The growth convertible index advanced 32.7% this past year, while value convertibles increased 21.19%.

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