Are you making new year’s resolutions?

Tarek Saber, head of convertible bonds at NN Investment Partners, on brainstorming resolutions.

If you’ve been brainstorming your investment resolutions for 2016, you’re not alone. The beginning of a year is a great time to revisit your investment portfolio. So how would convertible bonds (CBs) fit into an investor’s new year’s resolution?

The enigma for me, is why CBs remain outside the peripheral vision of such a large number of institutional investors. I have always been puzzled by the lack of curiosity into the asset class, particularly when looking at its great historical performance, with one of the highest risk-adjusted returns of any traditional asset classes. No one can argue the portfolio diversification qualities that CBs do deliver.

It is being argued in many publications that I have recently read that CBs are expensive. I can make the argument that most traditional asset classes are expensive. The problem being is that on what measure are they overvalued when we are all in unchartered territory. My conundrum is defining overvalued?

CBs are an ideal vehicle to navigate through uncertainty with as they have performed well in numerous investment cycles, if we can just agree on a number of known uncertainties that we as investors face in 2016 and in no particular order; we face new elections in the United States, potential currency volatilities/wars, Middle East tensions, oil/commodities volatility, rate rises/more QE (quantitative easing). These are just some of the uncertainties that we are aware of, as usual it is the unknown events that will cause the most disruption.

CBs offer a bridge between fixed income and equity markets, they have performed well in rising interest rates environments in the past and they have also historically performed well in low yielding environments, as witnessed by what happened in Japan.

It is important to comprehend what CBs offer and what is the costs of holding a CB, when comparing comparable coupons to fixed income bonds. What you give up over the tenor is the differential between the coupon of straight bonds versus the coupon of CBs but it’s always valuable to consider that what you are actually getting in return is a chance to participate in the underlying company’s good fortune going forward. Owning CBs allows you to have equity-like participation with half of the volatility. In the event of there being a bear market you will be more bond-like and in the event that we have an equity rally you will have greater exposure to equities. Historically we have had arguably a 30-year bond market rally which was ended by US rates having been raised in December 2015; on the other hand some other potential market forces that I mentioned earlier on in this column could see us head back to where we have been in the recent past with further QE in Europe and potentially even a return to QE in the United States.

I am not trying to predict the outcome of equity markets or fixed income markets. CBs will be a powerful portfolio diversifier through these challenging economic cycles. I am not a believer in passive investing especially in the current environment; I believe you need to be selective in what you own. We have our investment philosophy that we should choose to invest in the best companies wherever they are, using CBs to express our underlying equity conviction after satisfying ourselves that both the credit element (capital preservation), the theme conviction (value drivers) and equity participation (CB structure) meet our strict criteria for disciplined investment approach.

In that regard our New Year’s resolutions are a continuation of an All Years-plan to  showcase the importance of CBs in a diversified portfolio. As for investors: they might best view convertibles in terms of what contribution and improvement they can make to a portfolio as a whole. Because that’s what New Year’s resolutions are really all about: the commitment to improve.