Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson, and we have an old friend back here. Not old. Again, I always have to emphasize this, Pierre-Henri, because I'm not saying old in a literal sense. I’m not saying that you're an old person. You're actually very, very young.
I am not that young.
You're very young. And certainly, as people will learn, if they haven't heard you before, you're very young in spirit, which is what's most important. You have a very young, yet deep experience; the experience of age with the youthfulness and exuberance of a younger person. But we have our old friend because we've known him for a long time, Pierre-Henri de Monts de Savasse. I think we told the story of that on the last time we had you on as a guest. But it's always great to catch up with you. We always joke. We sometimes go and visit our teams in London. And Pierre-Henri always joins us for a presentation and a dinner. And everyone wants to sit beside Pierre-Henri at dinner because he's such an engaging conversationalist. And he's also very funny. And then — and just to set the record straight — you are my mother's favorite guest on the podcast. So this is almost like a mother's day gift from me to her.
Very touching, Dave. I'm so glad to be back on the podcast. Thank you so much.
We both thought that this was a particularly good time to have you on the podcast because of the opportunities that exist in the area of your expertise, the area that you manage. Pierre-Henri is a fixed-income manager with BlueBay Asset Management in London, but his specialty is convertible bonds. And there are different points in time where convertible bonds are particularly attractive to investors — we're going to go through all of that over the next several minutes — but this happens to be one of them, Pierre-Henri?
Absolutely. We are seeing a very good dynamics in the market.
Excellent. We did have Pierre-Henri on about a year and a half ago. If you subscribe to the podcast, you can download all the different episodes and you can go back and listen to the introduction to Pierre-Henri that we did, where we did a very detailed explanation of what a convertible bond is and how it works. If you want more detail than we're going to provide today, you can go back and listen to that podcast. But Pierre-Henri, briefly, can you explain the idea of a convertible bond and how it works, how it can be advantageous to an investor?
A convertible bond as its name indicates, is a bond. You've got almost traditional feature. A good old debt instrument. You've got maturity, you've got a coupon, you receive interest. So that's all good. In addition to those traditional features, as an investor, at any point in time, you can turn to the company and say, you know what? I have enough of this bond. Please give me shares instead. You agree at inception at a number of shares, and you can choose to do that and to convert your instrument into shares. As an investor, this is great because if the company you invest in is doing very well and the stock price does very well, of course, this is very beneficial to you because you can capture some of that upside. On the other side, if for all sorts of reason, the company is not doing so well, you still have a bond, and bonds are not too risky, right? You can still collect your coupons, and you can still ask for your money in the end. It's a very interesting way for investors who are very risk-aware, let's say — and I'm risk-aware, to be honest with you, and I don't want my portfolio to lose too much money in one go. I flag this feature to say, well, look, I feel good about this market. I want companies that go well. I want to participate in the upside, but I'm not ready to take all of the risks. This is exactly what convertible bonds do.
Again, for someone who likes the company. I like a particular company and I want to be invested in stocks. But I look out today and I see that the stock market has had a tremendous run. We've had a tremendous acceleration higher in stock prices over the last eight months. And so I'm worried about the market at an all-time high. I still like stocks and I still think there's opportunities there. But as we talk about young and old, maybe you're someone like me. You're a little older and you're worried about the downside. So this is a way that I can participate in some of the upside of the stock and protect my downside by actually owning a bond in the company. And I guess this is an overly simplified explanation, but that's how investors need to think about it in terms of how to use it as a tool in their portfolio.
Dave, I think you've summarized this market. It's a tricky market, but I think that you don't want to be out, you want to stay invested, and you want to diversify. So stay invested, stay diversified. It would be my advice. If you're out of this market, you're going to miss out. Maybe if you take too much risk, as you said, after such a large run, some pockets of valuation. So you want to be in asset classes which maybe have been a bit overlooked, that offer value, that offer a natural protection against volatility, let's say, or large moves, and convert all exactly in this category. Then this is the way I would see markets. That's why I feel quite positive about the asset class in the current environment.
Pierre-Henri, if I put my hat on as someone who doesn't work in the investment business. Again, if I take my mother, for example, and she's listening to everything we've said up to this point, Hi, Mom. She's there. But it almost seems too good to be true. Is there any time where a convertible bond doesn't work particularly well?
Yes. The past few months, for example, have been tough because convertible bonds are usually issued by smaller, mid to small cap companies, which have been really out of favor the past few months because it's all been about the main indices, the mega caps, the large caps. The performance of the companies in our universe has just been so-so. It hasn't been great, and certainly not as spectacular as the S&P 500, for example. This sector bias is one reason that has created a bit of divergence historically. I think that's the question. Is that a right time to look at converts again as a way to diversify your equity exposure? I think, yes, absolutely. It's been very interesting. Just a couple of days ago, chairman Powell clearly indicated that he was really thinking about cutting. The market took that quite positively, and we started having a big reversal between small cap outperforming, and large cap lagging. That's a big change. It was very good for converts. Our market gained almost 2% in two days, so starting to add quite a bit of value and to build more of a momentum. I think this is very interesting that we are about to change cycle. This is a very interesting time to precisely be more aware of your risk in your portfolio and how to diversify.
Chairman Powell, we've mentioned on the podcast before, he's the head of the Federal Reserve in the United States. Because of some of the economic data that's been coming out over the last three and a half months in the US, the language that he's using when he's speaking out in public is more towards the idea that rates have peaked and will start to come down and maybe as early as this fall. And then once that signal is sent out to the market, well, the market reacts to it. The companies that have been doing really well — we've talked about this with Stu Kedwell and other guests on the podcast — it's been very concentrated in these huge companies that are almost all in technology, and the rest of the market has not done as well. But it's done okay, as Pierre-Henri says. The convertibles have done okay, and you've got the bond protection. But what we're looking for as rates come down, it has a bigger impact on smaller companies. Of course, big companies get access to capital. They get access to the money that they need to fund their operations because they're big. They might even have the cash themselves. Smaller companies need to go out in the market to get capital to build their business. When rates are harder, it makes it harder on them. If rates are coming down, it makes it easier. That's why, for these companies and the convertible bonds attached to them, this becomes a very exciting place to be in the market.
Yeah, I think you're absolutely right. In convertible bonds, we do have tech companies. Often, not always. There are very wide range of sectors, but we do have tech company in this small mid-cap sector, which has been a bit out of favor. Why do they like converts? I can explain that in two minutes to our listeners. It's because issuing spread debt is very cumbersome for companies that are going very fast. Very cumbersome. They need to ask rating agencies, they need to pay them, they need to look at due diligence. It's quite hard. Issuing equity is also very demanding. It takes a lot of time. You need to go on roadshows. You need to talk to investors. If you do a convert, well, in a way, that solves your problem as a fast-growing company. You can raise capital. It looks like debt to start with. However, if your stock price does well, then everybody converts and your balance sheet is clean, and that's a very nice solution. It's also very nice because as an investor, your interests are exactly aligned with the management and the other stakeholders. This is the basic idea of the convert market. It's worked very well in the past. In the recent past, not so much, because the companies that issue converts have been a bit out of favor, as you've explained. We think that will change and that could really help our asset class to take off, frankly.
As you say, there's issuance in technology, but how big a market are convertible bonds and are convertible bonds issued in pretty much any industry? And are they issued the same in Canada and the United States as they are in Europe and Asia?
There are very few convertible bond issuances out of Canada. That's quite rare.
We're very small.
I'm not sure why, but historically, they've been quite rare. We invest globally. We look at opportunities across the globe. The market cap of convertible bonds globally is not that big as compared to the asset class, it's something very specialized. It's really something we are very proud to have at RBC GAM because it requires very specific experience and that created a lot of value over the years for the client. The market cap is $200 billion. That's the universe we monitor. We look at all regions, so mainly North America, the US. Europe is also a very large channel. We had a number of very strong performers at the beginning of the year. Industrials companies in Europe have done particularly well. We've got Japan, of course, and Asia as well. We are seeing quite a lot of companies in Asia and Japan coming to the market. As you know, Japanese equities have done very well. We've also managed to capture some of that upside. A lot happening. A lot going on across regions and sectors.
Again, this would be a broad range of sectors. You can very easily put together a very nicely diversified package of convertible bonds within a portfolio?
Yes, absolutely. I don't want to give you the wrong idea about the tech sector. We do have a number of consumers in tech, but we've got a lot more traditional sectors, industrials, as I've said, more consumer side, more staples and discretionaries. Really, the aim of our product is to build for you, for clients, a very diversified portfolio.
Now, Pierre-Henri, how long have you been working with convertible bonds in terms of your background?
I’m embarrassed. I started investing in convertible bonds in 2005. 20 years, next year. Can you imagine? That's a long time.
Yes. I know through that period, there's been some periods where convertible bonds have just been spectacular. Maybe you can give me more the exact date ranges, but I'm recalling a period from 2014 to 2017 or 2018, somewhere in that range, where convertibles were just very strong. What was the environment that created that big run in convertible bonds at that point?
I think you’ve got different types of drivers depending on the cycle. One period where converts was very strong was during COVID. A lot of issuances, a lot of companies raising capital for Capex. The market did super well. We managed to keep up with the S&P in 2020, for example. In the period that you were mentioning, most regions were coming out of this semi-recessionary period from the global financial crisis. And a fairly similar story: need for Capex, a lot of companies coming to the market and almost happy, I would say, to give some equity upside away, to raise capital and invest. Maybe that's the way I would characterize a good market for converts. The truth is, we can see exactly that in the coming years. We know Capex has been, as you said, very focused or very driven by the mega cap tech. It's all been about mega cap tech driving everything. Small mid-cap, other sectors, things like infrastructure in the US. You would imagine that we need a lot more investment in those sectors, but Capex has been very mute. We think that in a slightly higher rate environment, where Capex things are real, a lot more companies will come to the market to create a lot of opportunities. That's a slightly longer-term picture.
Yes. But again, it sets up the rationale for having that exposure to convertible bonds in your portfolio. Now, if you were to look at, say, a typical 60/40 portfolio — 60% stocks, 40% bonds, a balanced portfolio, as we would call it — what would be the placement for convertible bonds within that structure? Would you very clearly categorize it as part of your fixed income or bond holdings, or could you almost describe it as part of the equity holdings? Where exactly would you fit it in and how much would you suggest that someone look at for diversification reasons?
Well, very often for this kind of portfolio, our recommendation would be 10%. Let me give you two elements here. If I look at the universe currently, and we do that together with the team every day, we calculate what is our theoretical share sensitivity or equity exposure. We think it's around 40 or 50%. It varies. Sometimes it's closer to 60%, sometimes it goes up to 30%. Right now, we are around 40 or 50%. We are bang in the middle of a pure risk perspective. If you're replacing part of your balanced portfolio with some converts, you're probably there. It's exactly similar risk. Now, the question is, what are you most worried about? I think that a lot of people right now, as you said at the very beginning, Dave, they are thinking about locking gains on their equity position because it's been such a great run. If you've been into the headline indices, into the mega cap indices, you're thinking, oh, maybe I need to protect some of that. I think obviously, converts at this juncture, they fit in very well into that idea because bear in mind one thing, one very technical point, but I think very interesting, is that dividend yield in large caps have worked over the past six months. However, because rates have increased, the coupon you're getting on converts have actually gone up. From an income perspective, you are getting a much better profile, let's say, for convertible bonds as compared to more equity. That, I think, can be a very nice plus, if you start having more volatility.
As usual, you're right on top of my next question. I do notice in several dividend stocks that dividend yields have come down as the stock market has appreciated over the last couple of years. So this is, again, another way of getting equity exposure for those investors who are not super aggressive investors. As we've talked about, they want to protect that downside. So we often look at dividend stocks. We also want some income, which is important. Where we're sitting right now, it's been an overlooked strategy over the last few years because there's so many other areas of the market where the performance is just popping. And convertibles just chugging along behind the scenes. So you add that all up together and it really starts to create a compelling case to at least be looking at this area, if you're an investor.
You're absolutely right, Dave. For our asset class, as a portfolio manager in convertible bonds, it's been a tough sell. I'll tell you why. If you buy a convert, it's because you want to diversify your risk somehow. People are telling me, why do I want to diversify my risk? Equity markets are doing so well all the time. I don't want to diversify. You told me that last time and you know it's still going up. You're absolutely right. This is it. The argument is about diversification. We are one of those asset classes where you need to believe in the need for diversification. The past few months, the past few years, it's almost as if this idea of risk has been suppressed. But I think this is starting to come back because valuations, especially for mega caps, are at the extreme, of course. Because, naturally, investors want to lock-in gains. Because we're changing cycles as well. Because we're having a number of risk events still on the horizon, especially with the US election. There are lots of reasons to think that this is a very good time to think about this diversification argument again.
Of course, Pierre-Henri, we would never get on this podcast and make a very specific recommendation about an area of the market. We have our good friends who review this podcast before it's posted publicly, to make sure that we're not making recommendations. I'll say what they want me to say, which is always what we're trying to do here is open your eyes to different areas of the market, different things that are happening in the market. So in this case, this is a particular asset class that is widely overlooked. We're introducing it to you through the podcast. You can listen and get an understanding of why you might be interested in this. Then, of course, you're going to go to your advisor and you're going to talk to them about that. Maybe you have some exposure to convertible bonds already in your portfolio that you weren't aware of, and that's fantastic. Or maybe you don't have exposure and you can talk to your advisor about maybe it makes sense. There's never here a broad base that says go and buy this right now. But it's just to say, hey, here's something you may not have thought of. Make sure you check it out with your advisor or do the research yourself. It may be something that could add some real value in your portfolio. And historically, these kinds of circumstances have traditionally made this investment attractive, particularly from a diversification standpoint.
Look, Dave, I couldn't say it any better. I would even add that if you are interested, if your advisor managed to get you interested and you want to discuss more, we're here to help. I'm here to help.
Excellent. Mais c’est possible que tu puisses l’expliquer mieux en français que moi. En anglais, c’est possible pour moi, mais en français, je ne peux pas le faire. C’est l’accent Québécois. We've got lots of listeners in Quebec, so we like to throw in a little bit of French there. And Pierre-Henri, always great to see you. We didn't do a videotape of this one, but I know what I love about guests like Pierre-Henri when they come on: you can feel their smile through their voice. Because Pierre-Henri is always so happy and positive and does such a fantastic job in this very special space. So Pierre-Henri, thank you so much for joining us today.
Dave, what a pleasure. It was great as ever. And so all the best to all the listeners.