Fund of the Fortnight: Polar Capital Global Convertibles
Is it an equity? Is it a bond? No its ‘convertible’
Investors face a real conundrum in the current climate. Government bond markets are in turmoil as Greece teeters on a debt default and a rebound in the oil price is likely to see the return of inflation, making the recent ultra-low yields on such bonds unattractive. But there are also concerns about how long the multi-year bull market for equities can continue, with valuations looking quite stretched, especially in the US. And both these concerns are increasingly calibrated around the prospect of the US Federal Reserve potentially hiking interest rates this autumn after a prolonged period of rock bottom rates, which has supplied liquidity right across the globe.
One type of solution to this growing sense of caution might be to invest in a targeted ‘absolute return’ fund, as record numbers have according to recent industry data. These funds often use complex trading strategies and rocket-science investments such as derivatives to generate positive returns in all market conditions. But the trouble with these funds is that they offer little in the way of yield, so won’t suit income hungry investors.
A potential alternative for yield seeking investors who want to participate in further stock market rises if the good times continue to roll, but with an eye to limiting any downside, could be funds which invest in the convertible bond markets. In a nutshell, ‘convertibles’ are bonds which give the holder an option to exchange them for shares in the issuer at some point. Convertibles therefore rise when equity markets are on the up, but are much less sensitive to declines meaning they have a highly attractive risk/return profile with a stable source of income. In fact looking at over 40-year of data, US convertibles – which account for around 60 per cent of the market – outperformed the S&P 500 Index of shares by 215 per cent but with around half the volatility.
A fund that operates in this asset class often overlooked is the Polar Capital Global Convertible fund. Although only launched in September 2013, the team behind it, led by Stephen McCormick and David Keetley, are incredibly experienced with over half a century of investing in convertibles between them at leading investment banks and hedge funds. Importantly, the team operates from locations on both sides of the Atlantic: London and Connecticut.
The fund invests in a range of 50-80 positions at any given time, typically half of which will be in US names. The focus is to seek out attractively valued convertibles with good liquidity and a balanced risk reward profile, with fundamental credit analysis at the core of the investment approach to ensure downside protection. The active positioning and selectiveness of the fund is demonstrated by the fact it has less than 40 per cent overlap with its index. There is a very strong risk management discipline, with every position in the fund stress-test daily against scenarios of equity or credit market crashes. The team also manage risk through putting in place interest rate hedges.
Historically the convertibles market has often been dominated by investment bank proprietary trading desks and hedge funds but in the aftermath of the credit crisis, banks have reduced their balance sheets and made their business models more conservative. The Polar team argues that there is now less competition in the convertibles market from bank trading desks, shifting the advantages in favour of investors. This means new convertible issues are adopting structures which better meet the preference investors have for higher levels of fixed income.
With a current yield of 3.7 per cent, this fund offers a decent income, the potential to participate in further equity market rises but with a degree of downside protection. Another positive feature given the limited size of the convertibles market is that at less than £180m this is a small fund, which greatly enhances the ability of the team to trade the portfolio.