Salomon prepares to increase equity sensitivity of recommended portfolio

By Ronda Fears

Nashville, Tenn., March 11 - While the Salomon Smith Barney U.S. convertible recommended portfolio beat the firm's total convertible index last month, analysts Adrian Miller and Stuart Novick said in a report Monday that they are preparing to shift the pick list to boost equity sensitivity soon.

The recommended list again bested the broader index in February with a return of 0.18%, which was 262 basis points above the return of the convert market last month and a year-to-date outperformance of 592 basis points. The Salomon Smith Barney U.S. convertible index declined 2.4% last month, bringing the year to date figure down to about -4.1%.

"Looking ahead, recent news suggesting that the U.S. economy may be emerging from a recession is already having a positive impact on the equity markets. That should bode well for converts, too, although to a lesser degree given the convert market's present tilt towards credit sensitivity - 43.7% of the market, compared to 27.4% of the market on the equity sensitivity side," Miller and Novick said in the report.

"Nevertheless, a move higher for stocks would benefit convertible market returns and should also feed into the trend that is presently fueling an increase in the issue of more equity sensitive convertible structures like mandatories. That development is partly being driven by issuers looking to de-lever their balance sheets through the issuance of securities like DECS that are more likely to be viewed as equity by the rating agencies."

Moderately equity-sensitive coupon-paying bond issues should stay in the forefront of new issues as well, the analysts added. Investors' desire for the relative safety of yield-based returns as opposed to the greater uncertainty attached to capital appreciation is also behind the surge in issuance of these more income-oriented securities.

"Along those lines, we intend, over time, to increase the equity sensitivity of our recommended portfolio," said the convertible analysts in the report.

"To achieve that objective we'll probably add a few mandatory preferred issues and perhaps scale out of a couple of less equity sensitive names. At present, we continue to maintain considerable exposure to credit sensitive issues like zeros and short term busted coupon issues."

The portfolio benefited in part from advantageous stock selection, the analysts noted, since the stocks underlying the portfolio lost only 6.55% in February, compared to a 7.05% loss for the stocks underlying the convert index. The portfolio also was helped by a heavy weighting in cyclicals and a few energy names that performed relatively well as the economic outlook improved, the analysts added.

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