The recent mass exodus out of bonds — in which investors pulled more than $18 billion from funds that invest in bonds over a two-week period ending June 121 — may have left you searching for the best opportunities in the bond market.
I believe you should start your search with convertible bonds, which have historically had a strong track record of performing well in periods of rising rates and strengthening equity markets. Convertible bonds have dispelled conventional wisdom that says when interest rates go up, bond prices go down.
For example, while many investors shed their bond assets from early May through June 17, convertibles, as measured by the Bank of America Merrill Lynch All U.S. Convertibles Index, yielded 2.22% — more than 400 basis points greater than Treasuries and high yield debt.1 During this same time period, buyers of US Treasury debt lost 1.89%, and investors in high-yield bonds lost 1.83%.1
The positive performance represents a trend that has occurred in the convertible bond market, which over the last 25 years has outperformed straight fixed income in the seven of the last eight periods where the 10-year Treasury yield increased in excess of 125 basis points, as measured by Barclays U.S. Government/Credit Index.2
What’s more, convertibles have tended to have shorter durations, which has made them less sensitive to rising interest rates. The average convertible market duration is about 3 to 3.5 years currently, compared to 4.5 years for the corporate high-yield market and 5.5 years for the aggregate bond market.
So if you’re looking for a way to adjust your fixed income portfolio in a rising rate environment, you might want to consider this asset class, which combines the income and potential stability of a bond with the appreciation potential of a stock.
1 Source: The Wall Street Journal, “Bond Investors Head for the Hills,” June 19, 2013
2 Source: Bloomberg L.P.; As of March 31, 2013.
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Convertible Returns in Rising Interest Rate Environments |
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10-Year Treasury Yield Increase (bps) |
BofA Merrill Lynch® All U.S. Convertibles Index (%) |
S&P 500 Index (%) |
Barclays U.S. Government Credit Index (%) |
|
|
12/21/89 to 5/2/90 |
130 |
-2.99 |
-1.30 |
-1.91 |
|
10/15/93 to 11/7/94 |
287 |
-2.28 |
2.22 |
-5.15 |
|
1/18/96 to 6/12/96 |
154 |
11.97 |
11.42 |
-4.08 |
|
10/5/98 to 1/20/00 |
263 |
68.85 |
46.59 |
-3.38 |
|
11/7/01 to 4/1/02 |
125 |
2.29 |
3.07 |
-3.09 |
|
6/13/03 to 6/14/04 |
176 |
11.49 |
14.66 |
-3.64 |
|
6/1/05 to 6/28/06 |
136 |
9.46 |
6.71 |
-1.49 |
|
12/30/08 to 6/10/09 |
189 |
24.68 |
9.41 |
-2.08 |
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Source: Bloomberg L.P.; As of March 31, 2013. Basis point is the smallest measure used for quoting yields on bonds and notes. One basis point is one one-hundredth of a percentage point, or 0.01%. If the US Federal Reserve increases its short-term interest rate target by 50 basis points, or a bond’s yield rises by 50 basis points, the change would be 0.50% or one-half of one percent. The S&P 500® Index is generally representative of the US stock market. The Barclays U.S. Government Credit Index includes Treasuries and agencies that represent the government portion of the index, and it includes publicly issued US corporate and foreign debentures and secured notes that meet specified maturity, liquidity and quality requirements to represent the credit interests. The BofA Merrill Lynch All U.S. Convertibles Index is an unmanaged index that measures performance of US dollar-denominated convertible securities not currently in bankruptcy with a total market value greater than $50 million at issuance. Past performance cannot guarantee future results. Does not reflect or imply the performance of any Invesco fund. An investment cannot be made directly in an index. |
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Important information
All fixed-income securities are subject to two types of risk: credit risk and interest rate risk. Credit risk refers to the possibility that the issuer of a security will be unable to make interest payments and/or repay the principal on its debt. Interest rate risk refers to fluctuations in the value of a fixed-income security resulting from changes in the general level of interest rates. Non-investment grade securities (junk bonds) have greater risk than investment grade securities including the possibility of default. Convertible securities may be affected by market interest rates, the risk that the issuer will default, the value of the underlying stock or the right of the issuer to buy back the convertible securities.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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NOT FDIC INSURED |
MAY LOSE VALUE |
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