Barclay's recommended convert portfolio underperforms overall market for May

By Rebecca Melvin

New York, June 2 - Barclays Capital's 2009 U.S.-recommended portfolio rose 3.47% in May, underperforming the 5.72% return for the broader Barclays' convertible composite index, and the 5.59% return for the S&P 500, Barclays research said.

Year-to-date, the Barclays convert composite has returned 19.32%, second only to Barclays' HY Index, in terms of major asset classes, which returned 26.8%. By comparison, the S&P 500 returned only 2.96% year to date.

Given the defensive stance of Barclays recommended portfolio, which focuses on good credits, it wasn't surprising that it underperformed May's overall market, which was very strong and pushed everything up, both good and bad, Barclays said.

Convertibles' strong 5.72% rally for May was driven by strong returns in both equity and credit markets. The valuations of convert market in the last three months have benefited from tightening spreads and equity market bounce back, Barclays added.

"Given the defensive nature of the portfolio, we find the 62% equity participation rate healthy. Year to date, the portfolio has posted a 15.57% return, versus 19.32% for the index," Barclays analysts Venu Krishna, Manoj Shivdasani and Peng Cheng wrote in a report

Preferreds perform strongly

The type of convertible that outperformed in Barclays composite index was the convertible preferred. They ended the month up 17.2%, while mandatories were up 13.8%, and bond structures were up only 3.43%.

Because preferreds are very equity sensitive, and equities were strong in May, it wasn't unexpected that preferreds outperformed.

The type that outperformed for 2009 year-to-date was mandatories, which returned 35.4%, outpacing by double the returns of preferreds at 15.6% for the year to date, and of cash-pay bonds at 18.9%. Zero-coupon bonds returned 6% year to date.

By market cap, the best performing convertibles for May were small cap names, followed by large cap names, and lastly mid cap. But for the year-to-date, mid cap was the best performing segment of convertibles.

In the large cap category are a lot of financials, which have been out of favor of late.

Volatility falls

Implied volatility of investment grade convertible bonds with at least one-year of call protection ended the month of May at 32.2%, down from 35.0% at the end of April. Ninety-day realized volatility was up slightly, closing the month at 61.8%, while option surface vol fell to 42.6% from 45.8%.

Non-investment grade convertible bond spreads tightened 118 basis points from 1,410 bps to 1,292 bps while the Barclays' US HY B Index tightened 168 bps to 915 bps from 1,083 bps.

Investment-grade convertible credit spreads widened to 469 bps from 442 bps while the BarCap US Credit Index tightened 76 bps to 319 bps from 395 bps during the month.

The spread between Non-Investment Grade converts and the BarCap HY B Index ended the month at 377 bps from 327 bps at the end of April.

Merrill Lynch notes lack of large deals

A report on May issuance by Merrill Lynch noted that the month saw a pick up in the pace of new issuance, but the convertible market is still lagging other primary markets, amid a lack of large deals.

"A lack of large, billion-plus dollar deals put a strain on the overall new issuance volume and does not bode well for secondary market liquidity of the latest smaller deals down the road," Merrill Lynch analyst Tatyana Hube noted in a month end report.

Twenty new deals had an average size of $295 million, and raised a decent $5.9 billion in proceeds, the report said.

Redemptions remained high in May, with $4.8 billion in convertibles taken out of circulation during the month.

As issue terms remained attractive in May, investors continued to show a very robust demand for new convertible issues, resulting in many of them getting upsized.

Although the average at-issue cheapness increased last month to 6% from 5.2% in April, it was mostly driven by smaller deals with difficult stock borrow, and the market value-weighted at-issue cheapness stood at 5.3%.

The new issue index comprised of new issues priced during the last six months rose 4.8% in May, helped by a 7.3% gain by its underlying stocks during the month. Year to date, the new issue index is significantly ahead of the master index by over 48%, Hube wrote.

© 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.