Merrill says convert market continues to richen amid high demand, low supply

By Ronda Fears

Nashville, Feb. 4 - The U.S. convertible market continues to richen, according to Merrill Lynch & Co. analysts, but modest issuance helped boost convert performance.

Merrill's total U.S. convertible index "continued to richen in January as high demand for convertibles and a lack of adequate supply pushed their prices higher," said Merrill convertible analyst Tatyana Hube in a report Tuesday.

"The average discount to theoretical dwindled down to 1.33% at the end of January, the lowest level in seven years, from 1.55% at the end of December."

The average conversion premium for the master index remained flat at 97.8% at the end of January, while the average investment value premium contracted slightly to 18.4% from 19.6% during the month.

The delta of the index was a low 0.17.

"Investors were optimistic after the equity markets made healthy gains to start off the New Year," said Merrill convertible analyst Marc Malloy, in a separate report Tuesday.

"But skepticism soon replaced optimism as the equity markets skidded for the remainder of the month and ended in negative territory."

Still, the broad Merrill convert index not only outperformed the major U.S. equity benchmarks in January, gaining 1.6% on the month, but posted the gain despite their underlying equities dropping 0.3%.

The Dow Jones Industrial Average lost 3.3%, while the Russell 2000 declined 2.8% and the S&P 500 lost 2.6%. Nasdaq also started the year down, dropping 1.1%.

By comparison, in January 2002 the Merrill convert index dropped 1.6% as the Dow fell 0.9% and the S&P 500 lost 1.5%.

Speculative-grade convertibles soundly beat investment-grade issues in January but the high-grade issues did markedly better than their underlying stocks, Malloy noted.

Speculative-grades gained 3.7% as their underlying stocks increased 2.0%. Investment-grade converts, despite declining 0.2%, fared well when compared to their corresponding equities that dropped 2.2%.

Technology convertibles outperformed all other sectors, gaining 5.4%, which added 114 basis points to the index, as their underlying equities increased 4.1%. The sector advanced behind strong gains in converts issued by Lucent and Nortel Networks, Malloy noted.

At month end, the tech sector accounted for 21% of the entire U.S. convertible market and had a delta of 0.22.

Industrials was the worst performing sector in January, weighed down by Northrop Grumman, Cummins and Waste Connections. The sector slid 0.4% but held up well when compared to their underlying stocks, which fell 4.8%.

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