Recently, the performance of the convertible bond market has been somewhat volatile.
In just 9 trading days from June 17 to June 27, the volatility of the CSI Convertible Bond Index has increased significantly: the rise and fall of 2 days exceeded that of the Wind All A Index, and the absolute value of the rise and fall of 3 days exceeded 1%. The performance of this elasticity seems to be somewhat different from the "debt" investment varieties we usually perceive.
The recent trend of the CSI Convertible Bond Index
Data source: Wind, statistical interval: 20240617-20240627
If we analyze the performance of this round according to the main rating of the convertible bonds, we can observe that the market shows a certain trend of differentiation.
- The AAA performance is more robust
- Convertible bonds rated AA- and below also showed relative resilience
- AA-rated convertible bonds rebounded quickly this week after a significant decline last week
- AA+ rated convertible bonds fell more significantly in the past two weeks
Analysis of the rise and fall of the ratings of different convertible bonds
Source: Wind; Last week's index was 20240617-20240621, and this week's index was 20240624-20240627; "Weighted change" is the weighting of the transaction amount
If we take the closing price of June 14 as the benchmark, we can find that the convertible bonds in different price ranges show different trends.
- High-priced convertible bonds (closing above 130 yuan) experienced a more significant decline this week
- Low-priced convertible bonds (closing below 90 yuan) fell by more than 10% last week, but there was also a more significant rebound this week
- The market performance of medium-priced convertible bonds (closing between $90 and $130) falls somewhere in between
The rise and fall of convertible bonds in different price ranges
Source: Wind; Last week's index was 20240617-20240621, and this week's index was 20240624-20240627; "Weighted change" is the weighting of the transaction amount
In fact, convertible bonds are a relatively complex asset, which not only has the nature of fixed income of debt repayment and interest, but also has the nature of highly elastic derivatives of options, so its pricing and market volatility will be relatively difficult to understand.
The introduction articles on convertible bonds in the current market often emphasize its option nature, including complex financial engineering pricing methods such as the Black-Scholes model and Monte Carlo simulation.
However, these in-depth quantitative analyses may be too specialized and may not be directly applicable to a comprehensive and intuitive understanding of the convertible bond market for most investors.
Therefore, as an investment advisory team, today we hope to try to introduce the key knowledge points of various aspects that you need to understand in a more easy-to-understand way, including the underlying logic of the price and fluctuation of convertible bonds, and the detailed explanation of the special terms of convertible bonds, so that you can better get started with convertible bonds and make investments clearly.
01 What is the underlying logic of convertible bonds?
As a compound financial instrument, the source of income of convertible bonds can be summarized into two main aspects:
The first type: the income of the bond attributes
Like bonds, convertible bonds have the characteristics of regular interest payments and principal redemption at maturity. This part of the income mainly affects the lower limit of the price of convertible bonds, which is called the "debt" of convertible bonds.
The second type: the return of the option attribute
Within a certain time frame (usually looser), investors can choose to convert their convertible bonds into shares and sell them in the market at any time.
If the market expects the stock price to perform well, the price of the convertible bond will also rise, which constitutes a source of elasticity for the upward price of the convertible bond, which is called the "equity nature" of the convertible bond.
In general, the details of these two sources of income will be published in the terms of the convertible bond, such as the "debt" part of the convertible clause: the coupon rate and the method of interest payment are specified.
The "equity" part of the convertible clause: the price and time of the conversion are specified, as well as some special terms.
In summary, convertible bonds are an investment instrument with both debt and equity properties, with debt providing interest income and equity providing volatility flexibility.
Of course, there are logical limits to the price elasticity of convertible bonds. It is just that compared with the face value of 100 yuan, if the price of the underlying stock rises sharply, the price of the convertible bond may soar from 100 yuan to more than 200 yuan in a short period of time, showing a performance of more than 100%.
This is indeed more prominent than the fact that pure debt products, which seem to have the same word "debt", may be difficult to earn more than 10% a year. But equally, convertible bonds are certainly much riskier than pure bonds.
02 Two typical cases of convertible bonds
We can learn about the two aspects of "debt" and "equity" of convertible bonds from two specific practical cases.
Case 1: Typical "debt-based" debt swap
This is the market trend chart of convertible bond A in the past six months, and it can be seen that: on the whole, it shows a steady upward trend (with some normal fluctuations in the middle), which is similar to its financial bond index (green line) with similar duration.
Convertible bond A trend
Data source: Wind, statistical interval: 20231227-20240627
So why is it moving this way? We can analyze from its share transfer clauses:
In the special terms, the conversion price of convertible bond A is set at $13.24. This means that for every convertible bond A you hold, you have the right to convert:
If the company's current share price is $8.5, then exercising the conversion rights and selling them at the market price, the investor will receive:
This is much less than the face value of $100. As a result, investors are more inclined to hold on to the bond in anticipation of a fixed income when exercising and selling will result in significant losses.
After the vast majority of investors in the market form this consensus, the pricing logic of convertible bond A will be closer to that of bond assets, and its price will also exhibit similar volatility characteristics as bonds, that is, the so-called "debt".
Some readers may find that for any company, if the conversion price in the terms of its conversion (13.24 yuan in this example) is much higher than the current market price of the stock (8.5 yuan in this example), then no one will want to exercise the conversion interest, and everyone will treat the conversion bond as a bond, so will its trend be consistent with the trend of the bond?
In fact, we have a general term for this type of convertible bond: out-of-the-money convertible bond (figuratively understood as the conversion price is much higher than the market price).
If there is no special clause triggered or the company has a huge change in the stock market, then its price movement will be very similar to that of bonds, reflecting the "debt" side of the convertible bond.
Case 2: Typical "equity" convertible bonds
The following convertible bond B is more volatile, with a one-day rise of more than 10% and a decline of more than 5% on some days, and this sharp price swing is usually more similar to equities than the more stable bond assets we usually expect.
Convertible bond B trend
Data source: Wind, statistical interval: 20231227-20240627
Similarly, we can also analyze the causes of this trend from the difference between the conversion price and the stock market price.
It can be seen that the conversion price of convertible bond B is 7.74 yuan, which means that every convertible bond held has the right to convert this convertible bond into:
Assuming that the current market price of the company's shares is 11.5 yuan, if you exercise the conversion rights and sell them at the market price, you will get:
At this time, the return of converting shares and selling convertible bond B (148.6 yuan) is significantly higher than the return of holding as a bond and eating the principal and interest at maturity (which may only slightly exceed 100 yuan). In this case, investors will be more inclined to choose to convert shares and sell shares for higher returns.
After the vast majority of investors in the market have reached this consensus, the price of convertible bond B depends mainly on the market expectation of the stock price of the corresponding company.
Due to the large volatility of the stock price itself, this will lead to its price trend and risk characteristics closer to the stock market, showing obvious "stock nature".
Convertible bonds such as the conversion price (7.74 in this example) that are much lower than the current market price of the stock (11.5 in this example) are called in-the-money convertible bonds.
Investors who hold this kind of convertible bonds are more inclined to obtain potential gains in the stock market through equity conversion, rather than relying on the fixed principal and interest income of bonds, so they show a "stock-like" side in terms of price trend and risk characteristics.
In fact, there is a third type of convertible bond in the market, that is, a balanced convertible bond between debt and equity, so we will not repeat it.
Here, the differences between the three different styles of convertible bonds are summarized in the following table, and interested partners can take screenshots to save.
In the above, we also saw that there are three important special terms for convertible bonds, namely: resale, forced redemption, and downward revision. So how are they triggered, what happens to the rights and interests of all parties when they are triggered, and how do they affect the price of convertible bonds?
03 Three important special terms: resale, forced redemption, and downward revision
Special Terms for Convertible Bond B
1 Sell back
- Trigger condition: The price of the underlying stock is continuously lower than the trigger price of the resale (5.18 yuan in the above terms, which is generally linked to the conversion price, which is about 70%).
- Change in equity: The investor has the right to sell the convertible bond to the issuing company at par value + accrued interest (just like a bond redemption).
- Impact on the price of convertible bonds: A company usually issues convertible bonds to attract investors to become its shareholders, rather than hoping that they will simply redeem the convertible bonds as bonds. As a result, companies have an incentive to keep the underlying stock above the sellback trigger price.
2 Forced Redemption
- Trigger condition: When the price of the underlying stock is continuously higher than the redemption trigger price (9.62 yuan in the above clause, which is generally linked to the conversion price, which is about 130%), the company has the right to carry out forced redemption (but not every company will exercise this right).
- Equity change: After a period of publicity, the company forcibly redeems the convertible bonds in the hands of investors at the price of face value + accrued interest (just like bond redemption).
- Impact on the price of convertible bonds: The main purpose is to urge holders to quickly sell or exercise the convertible bond to avoid huge losses (at this time, the value of the convertible bond and the market price of the convertible bond are much greater than the principal and interest of the pure debt that can be recovered by forced redemption). In this case, the price of the convertible bond will generally fall because some investors choose to sell.
An example of a forced redemption announcement of a convertible bond
3 Correction (Correction)
- Trigger condition: When the price of the underlying stock is continuously lower than the revised trigger price (6.66 yuan in the above terms, which is generally linked to the conversion price, which is 80-90%), the company has the right to revise downward.
- Equity changes: the company may lower the conversion price (for example, from the original 7.40 yuan to 6 yuan), and the number of shares that investors can convert into if they hold 1 convertible bond increases (the number of shares that can be converted = par value / conversion price, the denominator decreases, and the numerator increases); At the same time, the price of the resale and foreclosure will also fall as the price of the new conversion price falls.
- Impact on the price of convertible bonds: The number of convertible bonds that can be converted into shares increases, assuming that the company's stock price remains unchanged, the value of the convertible bonds (the number of convertible shares × the stock price) increases, which is very positive for the price of convertible bonds.
We summarize the logic of the price changes of these three special terms as follows, so that you can take screenshots and save them.
The logic of the price change of different special terms
Source: GF Fund
Well, after the above combing, you may now be more familiar with the asset of convertible bonds. However, in actual investment, convertible bonds have a high threshold for participation and large fluctuations, and direct investment requires a lot of energy and capital.
Therefore, we actually recommend you to indirectly allocate through public funds or fund investment advisory portfolios, and the rich market experience and professional analysis capabilities of investment research institutions can help you effectively diversify risks and reduce the complexity of investment.
As a professional investment advisory team, we will also strive to select convertible bond funds with excellent long-term performance and appropriate drawdown control in the process of building an investment advisory portfolio, and strive to amplify the overall alpha return of the portfolio and bring a better investment experience.
However, the ability of public fund managers and investment advisory teams is mainly reflected in what aspects of convertible bond investment, and how should they screen suitable convertible bond funds?
Today's article is already very long, and we will explain it in detail in the follow-up columns, and interested partners can pay attention to it~
Article source: GF Fund Investment Advisory Team丨Risk Warning: GF Fund carries out fund investment advisory business based on the principles of diligence, honesty and trustworthiness, and priority for investors' interests, but it does not guarantee that each investment advisory portfolio will be profitable, nor does it guarantee a minimum return. Investors participate in the fund investment advisory business, and there is a risk of loss of principal. The risk characteristics of a fund's portfolio strategy are different from those of a single fund product. The performance of each portfolio strategy under the fund investment advisory business is only representative of past performance and is not indicative of future performance, and the income created for other investors does not constitute a guarantee of business performance. As the fund investment advisory business is still in the pilot stage, there is a risk that the pilot qualification of the fund investment advisory institution will be cancelled and it will not be able to continue to provide services. Before investing, please carefully read the investment advisory agreement, strategy brochure and other legal documents, fully understand the details and risk characteristics of the investment advisory business, choose a portfolio strategy suitable for you, and invest cautiously