Merrill: Convertible returns year to date up 7% versus 0.9% gain for convertible hedge returns

By Ronda Fears

Nashville, Dec. 1 - Merrill Lynch & Co. convertible analyst Tatyana Hube noted in a report Wednesday that all major U.S. convertible indices and equity benchmarks posted the best month of 2004 in November, plus convertibles solidly outperformed straight bonds. The outright strategy for convertibles also has been besting the hedged strategy in 2004.

"The U.S. equity market shrugged off worries of decelerating profits, rising commodity prices and the falling U.S. dollar that have been dragging down the market," Hube said in the report. Thus, she added, "The surge in equities helped convertibles to solidly outperform straight bonds during November."

The Merrill convertible index in November was up 3.6%, behind a 6.9% increase in underlying stocks. Comparatively, the Russell 2000 was up 8.7% while the Nasdaq gained 6.3% and Dow Jones Industrial Average advanced 4%. Merrill's high-yield bond index advanced 1% in November, while the Merrill corporate bond index declined 1%.

Year to date the Merrill convertible index was up 7.0%. The hedged strategy was not doing as well, however.

Through the end of November, the Merrill Lynch convertible hedge index for 2004 was up a meager 0.9% before hedging out interest rates. Spreads made the highest negative contribution to the hedge return in November, Hube said. The spread on the Merrill Lynch high-yield bond index contracted to 318 basis points from 364 basis points during November, she noted.

Junk paper still outperforms

Speculative grade convertible bonds continued to outperform their investment grade counterparts in November and year to date.

For November, speculative grade converts gained 5.3% while investment grade converts rose just 2.5% and year-to-date speculative grades advanced 10% compared with the 5.1% gain produced by the investment grade group.

Although the small cap convertible index outperformed in November, Hube said "investors have clearly exhibited a preference for large cap convertibles year to date."

Small cap convertibles advanced 4.6% during November as underlying stocks gained 8.8% and year to date those convertibles were up 5.2% despite a decline of 1.8% in the underlying equities.

Large cap convertibles gained 3.3% during the month as the underlying stocks gained 6.1%, but were well ahead of small and medium cap convertibles thus far in 2004, with a year-to-date gain of 7.8% as the underlying equities climbed 14%.

Prices surge on bargain hunting

Convertibles richened in November on bargain-hunting, Hube said, with the average discount to theoretical for Merrill convertibles index falling to 0.49% cheap from 0.60% cheap at the end of October.

In November 2003, Merrill statistics show convertibles were trading at about fair value, versus about 1.5% cheap in November 2002 and around 3.5% cheap in November 2001.

During the month, conversion premiums contracted further to 41.6% at the end of November from 45.5% at the end of October. At the same time, the average investment value premium improved to 36.3% from 33.7% on rising yields.

Negative net issuance persists

Despite strong positive secondary market performance during the month, the market value of the convertible universe dropped further by $0.6 billion in November, due to primary market negative net new issuance of $10.4 billion for the month.

The total market value of Merrill's master convertible index decreased to $283.9 billion at the end of November from $284.5 billion at the end of October.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.