Biotech, pharmaceutical convertibles the safest bet after a big selloff, Merrill Lynch says

By Evan Weinberger

New York, Aug. 1 - Convertibles suffered their worst week in 2007 last week, a new report issued Wednesday by Merrill Lynch equity linked analysts says.

If convertibles don't rebound quickly, the report adds, it might take a while for them to come back.

Following a big sell off, the analysts point to pharmaceutical and biotech convertibles as a safe place to invest.

The Merrill Lynch analysts say that the convertibles market shrank by 3.6% during the week ending July 27, compared to the S&P 500's fall of 4.9%. Credit spreads also widened significantly during the course of the week. According to the report, the CDX8 widened 11 basis points to 512 bps as of July 26.

According to analysts Yichao Yu, Tatyana Hube and Yaw Debrah, there have been 31 weeks where convertibles have lost more than 2.5% since January 1988. Convertibles held their ground in the following four weeks 58% of the time and 64% of the time after eight weeks.

"However, if the convertible market failed to generate a positive return after 8 weeks, it could take 20 weeks or more to just post a cumulative gain," the report says.

As the analysts expected, large-cap investment grade convertibles historically outperformed convertibles issued by speculative grade companiess by an average of 220 bps during sell-off weeks. In the next four weeks, investment-grade convertibles were up 21 bps over speculative grade and up an additional 30 bps after eight weeks.

Convertibles issued by companies producing consumer staples, pharmaceutical firms, financial firms and other traditional defensive sectors performed better than other sectors during sell-offs. But that didn't necessarily hold true in following weeks.

A large part of the sell-off in convertibles in recent weeks has been in the financial sector, as convertibles issued by companies involved in mortgage lending and home building have been hit over the subprime mortgage crisis.

The Merrill Lynch suggests investors stick with high quality bonds from companies with large cap stocks in defensive sectors that are in developed markets and have high-quality income-oriented strategies.

The analysts made special note of biotech and pharmaceutical convertibles, noting that historically they tend to be the best performers following a sell-off. Among the companies the analysts highlight are Amgen Inc., Genzyme Corp., Teva Pharmaceutical Industries Ltd., Wyeth, Bristol-Myers Squib Co., Gilead Sciences Inc., Allergan, Inc., Schering-Plough Corp. and IVAX Corp.

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