Asian convertible bonds expected to continue to outperform equities and vanilla bonds as rates rise
Strong issuance of convertible bonds – particularly by Chinese companies – will extend into new year, say bankers and investors
Riding on record high share prices in Hong Kong and the United States, Chinese listed companies have this year reaped cheap financing through convertible bonds, an equity-linked hybrid instrument that gives investors fixed-income returns and the prospect of profiting from a rise in the issuer’s equity.
In a few cases, issuers such as social media giant Weibo and consumer electronics maker Haier Group were able to issue at 1.25 per cent and zero-coupon bonds, respectively, attractive pricing terms not achieved by most Asian issuers since the global financial crisis. The zero-coupon bonds enabled Haier to lock in financing of US$1 billion for as long as five years without paying any coupon during the bonds’ tenor.
More notably, the two deals – completed around end-October to November – underlined investors’ strong appetite for convertible instruments. As the US Federal Reserve is expected to continue raising rates in 2018, bankers and investors alike expect stronger convertible bond issuance and performance than plain vanilla bonds. The Fed has raised the federal funds rate three times this year to a target range of 1.25 per cent to 1.5 per cent.
“As interest rates have started rising, we see some companies starting to look at convertible bonds as an alternative to straight vanilla bonds due to the former’s compelling cost advantage. With convertibles, the call option embedded in the bond gives additional value to investors, cushioning them from the full impact of rising interest rates compared with vanilla bonds,” said Eva Zhong, head of convertible bonds origination for Asia-Pacific at Credit Suisse. Generally, as benchmark interest rates rise, bond pricing in terms of yield to maturity is likely to track closely.
As of December 21, convertible bonds issuance reached US$29.29 billion in Asia excluding Japan across 115 deals, data from Dealogic shows. The issuance value was higher compared with 2016 and 2015, but deal counts in 2017 have lagged behind the 152 recorded in 2015.
With all the major equity indices in the US and Hong Kong hitting record highs – the Dow Jones Industrial and Nasdaq Composite reached record highs on December 18, whereas the Hang Seng Index hit its record of 30,000 on November 22 – issuers have taken cue from bullish equity markets to issue convertible bonds as they took their stock’s high closing levels to set the reference price, based on which investors can swap their bonds into stocks.
In October, Nasdaq-listed Weibo was able to bank on the gains of its American depository shares, which have more than doubled this year up to its pricing date in October, to raise US$900 million in its five-year convertible bond debut.
Credit Suisse, which was a book runner for Weibo, priced the deal at a hefty conversion premium of 47.5 per cent over the closing price of Weibo’s American depository shares of US$90.35 on October 25. A higher conversion premium is in the issuer’s favour as it results in less equity dilution when the bonds get converted.
Gaurav Maria, Asia-Pacific head of equity-linked origination for JPMorgan Chase, said companies that are going through high growth, which are looking for low-cost financing either for capital expenditure investment or those that need to refinance existing debt or finance acquisition and merger activities, are likely to issue convertible bonds.
“We expect China to continue to dominate convertible issuances in 2018. For the past two years, we have seen investors getting exposure through convertible bonds into issuers that operate in the new economy, such as Chinese technology and internet companies,” said Maria.
JPMorgan was the lead manager for Chinese online travel company Ctrip.com International’s convertible bonds, which raised more than US$2 billion from two deals done between 2015 and 2016. It was also the sole book runner for Haier’s US$1 billion exchangeable bond issue in November, whose proceeds were used for debt repayment. In June 2016, Haier bought the home appliance business of General Electric for US$5.6 billion.
Asset managers, meanwhile, point out that given interest rate increases are likely to create volatility across asset classes, they expect convertible bonds to outperform straight bonds and equities.
Shaniel Ramjee, co-manager of Pictet Asset Management’s strategic income fund, said based on historical data, convertibles were the strongest performers across various fixed-income asset classes during periods of interest rates increases.
“From a strategic perspective, we like convertibles for their abilities to capture the upside potential of equities through options, while offering the downside protection of bonds,” said Ramjee.
Skander Chabbi, BNP Paribas Asset Management’s chief investment officer for convertible bonds, said while convertible bonds’ average yields were often less attractive than straight bonds, Asian convertible bonds provided exposure to exciting sectors in China such as banking and utilities, for example.
“The domestic Chinese market may also be a provider of a substantial amount of convertible bonds in 2018, as companies look for new ways to conduct funding and as the bond connect scheme appeals to more international investors,” he said.