Salomon analysts suggest high gamma convertibles for defensive plays

By Ronda Fears

Nashville, Tenn., Feb. 27 - Investors are looking for cover given that convertibles have become more credit sensitive amid market sentiment that is heavy with liquidity concerns and doubts about stock price recovery. Salomon Smith Barney convertible analysts suggest there are several high gamma plays that can provide shelter in the form of downside protection should stocks continue to languish but also a position for any rebound.

"While the relative returns of the convertible market have been attractive, compared to other asset classes, market sentiment has forced many convertible investors to look increasingly at defensive names," said Salomon Smith Barney convertible analyst Adrian Miller in a report Wednesday.

"These issues would position investors for the eventual rebound in economic activity and corporate earnings growth while offering a measurable degree of downside support in the event the market remains in its current malaise. In other words, convertible which possess a good leverage profile or high gamma."

Over the past 13 months a large portion of the convertible market moved from being considered equity sensitive into the credit sensitive category. From year-end 2000 through the end of January, the weighted average percent of the convertible market considered equity sensitive fell to 29% from 52%, the analyst noted, while the credit sensitive category ballooned to 42% from 26%. Weighted average conversion premiums spiked to 50.7% from 36.6% and, consequently, the weighted average delta fell to 50.5% from 65.8%.

In looking for defensive plays, the Salomon analysts looked for convertible bonds of more than $100 million with an equity market cap of over $150 million and delta less than 50%. Then, the analysts tried to construct a list of issues that would accomplish the goal of downside support, using a combination of absolute gamma levels and trading statistics that combined could show the leverage profile of a given issue with an attractive risk/reward profile.

"Since we are not convinced that relying on a model generated up/down leverage analysis as being the most effective way of identifying these prospective candidates, we attempted to fold in current trading statistics to help narrow in on prospects," Miller noted in the report.

The Salomon analysts came up with a list of 74 convertible issues that may be of interest to convertible investors looking for high gamma plays, including Affiliated Computer Services, Amgen, Brocade, Calpine, Cendant, D.R. Horton, Extreme Networks, Fleming, Gtech, HCC Insurance, Health Management Associates, Inco, International Rectifier, Interpublic, Invitrogen, J.C. Penney, Johnson & Johnson, Kerr-McGee, Lamar Advertising, Lear, Legg Mason, MedImmune, Peregrine Systems, Quest Diagnostics, Reebok, ResMed, SPX, Tekelec, TelMex, WellPoint Health Networks and XL Capital.

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