Falling stock prices mean that investors have to rely increasingly on the bond part of the convertible securities for returns.
Falling Asian convertible bond prices imply default rates as high as 55 percent, creating opportunities for investors willing to ride out short-term volatility, a Morgan Stanley analyst said.
About a quarter of the hybrid debt in the region trades at yields of more than 10 percent while a year ago none gave that level of payoff, Hong Kong-based analyst Viktor Hjort said. The prices imply default rates ranging from 10 percent to 55 percent, compared with a five-year historical rate of 20 percent for high-yield bonds globally, he said.
As falling share prices reduce opportunities for investors to profit by exchanging hybrid debt into stock, they increasingly have to rely on the bonds alone to deliver returns. Asian markets account for three of the world’s 10 worst-performing stock benchmarks this year, with China’s CSI 300 Index losing 51 percent, according to data compiled by Bloomberg.
“This market is becoming a busted universe, offering little equity value,’’ Hjort said. “As stock markets are repriced, people should treat the share option portion of a convertible bond just as a lottery ticket and start looking at the asset from pure credit fundamental perspective.’’
More than $1.4 trillion of equities worldwide are now on loan, about a third higher than at the start of 2007, data compiled by Spitalfields Advisors, the London-based firm specialising in securities lending, show. Almost all of that is being used to speculate shares will fall, according to James Angel, a professor at Georgetown University who studies short-selling.
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Negative Yields Investors were willing to accept negative yields of as much as 11.5 percent in January to buy Reliance Communications Ltd.’s zero-coupon convertible bonds maturing in 2011, as the company’s share price on Jan. 9 climbed to a record 821.55 rupees, 71 percent higher than the 480.68 rupee conversion price set when the $500 million of securities were sold in March, 2006.
Investors are now asking for more than 5 percent yield to buy the bonds of the Mumbai-based company, India’s second-largest mobile-phone operator, as the stock has fallen 48 percent from its record, according to Nomura Holdings Inc.’s prices.
Asia’s convertible bond market faces a “technical vacuum’’ as equity-focused investors cut investments amid falling stock markets while traditional credit funds have not embraced the asset, Hjort said.
‘Dead Market’
“Asia’s convertible bond market has been decimated by the reduction of banks’ proprietary trading desks and hedge funds in the past year. The investors pool is probably cut by half,’’ said Eugene Kim, chief investment officer of Tribridge Investment Partners Ltd., a Hong Kong-based hedge fund managing $170 million. “There are some very compelling valuations out there but the market is dead, risk appetite is not there.’’
The 1.83 billion yuan convertible bonds of Hopson Development Holdings, a real estate developer controlled by Chinese billionaire Zhu Mengyi, gave a negative yield for most of the second half of last year, according to Lehman Brothers Holdings Inc.’s prices.
The Hong Kong-based company’s shares plunged 75 percent from a record HK$31.25 on Nov. 1 and the bonds now pay 18.3 percent yield. Hopson’s $350 million 8.25 percent bonds, which are not linked to its equity, pay 23 percent today, ING Groep NV’s prices show.
“It’s time to look at the assets from a slightly longer-term view. In Asia, once the sentiment turns, the convertible bond market tends to move very rapidly,’’ Hjort said.
Convertible bond sales rose to a record of $186.7 billion last year as the highest stock volatility since 2003 boosted the appeal of securities that can be exchanged for shares. Volatility makes options to exchange bonds into stock more valuable because there’s a greater chance of reaching the conversion price.
The benchmark Chicago Board Options Exchange Volatility Index, or VIX, which is derived from prices paid for S&P 500 options, reached 32.24 in March, the highest since 2003 and was up from 12.04 at the start of 2007.
The author is a Bloomberg News columnist. The opinions expressed are her own.