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Pierre-Henri de Monts de Savasse, Senior Portfolio Manager, BlueBay Asset Management, joins Dave for a discussion about convertible bonds. Pierre explains the important role this asset class plays in a diversified portfolio, particularly given the uncertainty of the current market environment. [11 minutes, 21 seconds] (Recorded September 24, 2020)

Transcript

Hello and welcome to the Download. I’m your host, Dave Richardson. I am really excited to be joined today by Pierre-Henri de Monts de Savasse or, as he is known to his friends and colleagues, P.H. He is a senior portfolio manager at BlueBay Asset Management, with a particular expertise in a really interesting asset class, convertible bonds. P.H., welcome to the podcast.

Hi, Dave. It’s good to be with you.

It is great to have you. So for investors who are not familiar with the asset class itself -- convertible bonds. Could you give us a brief overview on what it is, and how it fits in a portfolio between bonds and equities?

Yes. Let me run through what is a convertible bond. A convertible bond is very much a bond. You’ve got all the traditional features of the bond. When you invest, you lend money to a company for a fixed period of time, and you receive interest. So that’s the most basic feature of a convertible bond. Now, where it becomes really cool is that in addition to this traditional kind of bond-like investment, you’ve got an option as an investor. You can decide at any point in time to turn back to the company and say, you know what, I’m done with this boring bond. I want shares instead. So you agree a fixed number of shares at the inception of your investment, and if things go well, of course, you would prefer to have shares. The great thing is that you can participate in the growth of the company. If the share price does well, you can make money on your capital, unlike a traditional bond. So it’s really great. And also it’s a win-win situation between the issuer and the investor. As an investor, as I said, you can make money beyond your original investment, and that’s really good. But as a company, if you do a good job and your stock price does very well, come maturity of the investment, you don’t need to repay the debt. You just give shares to people. And so you are clean. You don’t have debt anymore. That’s why some sectors, especially in the tech sector, the tech companies, they love this kind of vehicle to raise the capital. And we do have a lot of tech companies issuing convertible bonds.

For someone who’s used to investing in traditional fixed income, are they taking on a lot more risk in a convertible bond? Or, for an equity investor, is this a less risky way of playing in equity for a particular company?

It’s a good question. I got carried away by the upside of the instrument, but of course, you’ve got the risk element. And as I said, if things don’t go too well, you still have a bond. So you will get some coupons and you’ll get your principal at maturity. It’s a bit boring if things don’t go too well, but look, it’s safe. It’s nice. This is something that worked obviously very well for both credit and equity investors. Protecting the downside in the sell-off we had in March 2020.

The asset class has done very well this year. What’s really driving the strong performance of the convertible bond asset class this year?

You’re right Dave, it has been a great year for convertible bonds. I mean, what a year it’s been for all of us. But the asset class has done very well. In fact, as we speak, our Canadian convertible bond fund is up more than 10%, year to date. So I think it’s a really good result. Look, I think it’s interesting, I talk you through how the asset class reacted in this pandemic and with this big crisis. And I know you’re a soccer fan, Dave. So I’m going to say it has been a game of two halves, to use a big English expression. It’s been a game of two halves. The first part of the year, we had this massive sell-off in March when everybody went into lockdown. Obviously, equity markets were affected very badly. So, convertible bonds played their role in the sense that very quickly they lost equity optionality and convert investors were left with, as I said, a portfolio of fairly boring but rather safe bond or fixed income instruments. So that protected your downside. Losses were fairly limited in March. And then came phase two. That was rather remarkable because we had so many companies coming to our market to refinance. Maybe it’s worth a bit of an explanation. But remember, at the end of March, all these companies — sometimes great businesses, very good companies — they were contemplating the idea of adding no revenue for the foreseeable future. They had to refinance, they had to make sure they had enough money to go through that crisis. And they were looking for the best place to raise capital. In fact, converts was one of those places where they could raise capital in a very efficient fashion. The beauty of it, as far as investors are concern, is that those companies were so keen to raise capital that they were happy to give convert investors a lot of equity upside, cheap optionality as we say. Because, look, you allow me to refinance in a very tough time; I’m going to give you more upsides than normal. And that worked obviously very well. We also had, as I said, the tech sector which is a big issuer in our sector. So a lot of those tech companies started doing very well as everybody was working from home and being online a lot. So they thought we need more capital as well to invest. They also came to the market. So we had a conjunction of those two things: good companies that wanted to raise financing to survive and tech companies raising capital to invest. And obviously these two segments did super well. That’s how converts managed to recoup losses from March very early on and actually made new highs and have offered a strong positive performance this year. It’s really been remarkable.

We’ve been talking with other investment managers on this podcast about where we sit today. We have an election in the United States coming up. We’ve had some people on talking about Brexit and what’s happening in European markets. A second wave of COVID-19 starting to cause some concerns in Europe and in North America as well. So as we look forward, perhaps now into extra time. Using your soccer analogy, is this still an asset class that is well positioned or are you a little more concerned about the next while in convertibles?

We are. In fact, we are as excited as ever with the team for two reasons. One, as you rightly said, I think that an important point for the foreseeable future will be uncertainty. I think that this will be the key word in financial markets. And the other key element is very low rates. If you’re an investor and you’re thinking, well, it’s going to be uncertain and I’ve got very low rates, what do I do with my money? Because if I buy equities, it’s going to be very volatile and that’s a bit scary. It is generally scary. If I buy bonds, the 10-year US rates are below 1%. How am I going to make money on that? And so I think that’s why converts are so well positioned, because you’ve got a chance of making money beyond your yield component. But at the same time, you still have this protection to the downside. And so in volatile markets, as we saw in March, you will be protected as compared to a pure equity investment. So this is a rather good set up. And the other thing which I think really plays in favour of the asset class is that this COVID-19 crisis has been a trigger, an inflection point. Big change. We’re going to have new economy sectors doing always better and older economy sectors struggling a bit. As we saw, converts are a fantastic way for new economy sectors to raise capital. We feel, together with my team, that it’s been really an inflection point for our asset class. More and more companies want to issue in the tech sector, biotech sector, high growth sectors, and more and more investors are starting to look at the asset class as well. I was going to say there is a real buzz, but I think it’s a more than that. I think there’s a structural change. You know, life will never be the same after this crisis. And I think converts would probably be one of the big beneficiaries.

Well P.H. that is a great overview of an asset class that I’m sure many Canadian investors have not thought a lot about, or maybe even weren’t aware of. The uniqueness of the asset class has clearly positioned it well for this year. If you’re correct in your assessment, it may be something that is positioned well for the coming year as well. So the only thing I say in terms of things returning back to normal, for the listeners, you can probably tell just from this conversation. Pierre-Henri is a fabulous person to get seated beside at a dinner function. A fantastic conversation over dinner. And I only hope that things will return back to normal so we can share another conversation over a meal, Pierre-Henri. So thank you so much for your time.

I would be delighted. Dave, I would love that so much. I miss those conversations, believe me.

Excellent. Well, hopefully in the meantime, we’ll get you back for an update on the podcast. But thanks again for your time today.

My pleasure Dave. Goodbye.

Disclosure

Recorded September 24, 2020

RBC Global Asset Management is the asset management division of Royal Bank of Canada (RBC) which includes RBC Global Asset Management Inc., RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, RBC Global Asset Management (Asia) Limited, and BlueBay Asset Management LLP, which are separate, but affiliated subsidiaries of RBC.

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