Investors ride out China uncertainty in convertible bonds

By Georgina Lee

HONG KONG (Reuters) – Investors keen for exposure to China’s economic reopening but unwilling to wager unreservedly are turning to convertible bonds issued by Asian companies, so that they get paid an income while being positioned for some upside if stocks rally.

Funds that invest in Asian convertible bonds attracted inflows of $118.1 million in January and February, data from Morningstar shows, bucking the overall outflows recorded for the more than 350 convertible bond funds it tracks globally.

The flows have gone into convertible bonds of firms whose shares have been in long decline, many of them Chinese companies in the internet, technology and airline sectors listed in Hong Kong, which can push convertibles pricing into a so-called sweet spot.

Convertible bonds are hybrid securities with most, like a regular bond, paying a coupon.

The value of the convertible bonds is sensitive to prevailing interest rates but their price also depends on the company’s stock, as they include a conversion option, so some investors see bargains in convertibles of beaten-down firms.

“Some Asian convertible bonds are attractive as they offer investors comparable or better yields for a shorter duration than straight bonds, as they come with an inexpensive equity option,” said Girish Kumarguru, portfolio manager at alterative asset manager, China Everbright (OTC:) Assets Management.

Convertibles of China app platform Meituan, smartphone maker Xiaomi (OTC:) Corp and Korean steel maker Posco Holdings are all trading at attractive levels for investors to own the convertibility option, since they are priced more or less like bonds and the option cost is minimal.

This means that conversion prices are far higher than current stock prices. But it also means cheap exposure to the potential upside – something not offered by a regular bond, while it pays an income not available with a regular option.

Hong Kong flagship airline Cathay Pacific’s 2.75% 2026 convertible offers an example.

Compared to the 6% yield paid by its regular bond, convertible bond investors get less, with current pricing implying a yield of around 2.5%. But with the stock at HK$7.53 and rising, it is getting closer to the HK$8.57 conversion price – a level where investors have exposure to stock price gains, and protection on the downside thanks to the bond value.

Fund managers say China’s reopening could drive similar dynamics in other sectors.

“Measures to boost consumption in China should be favourable to Asian convertible bonds as there are numerous consumer-related issuers in this region,” said Skander Chabbi, head of global convertible team at BNP Paribas (OTC:) Asset Management based in Paris.

Recent volatility in fixed income markets has stalled some flow into convertibles, but traders expect it can pick up again.

“Trading volume was massive in Jan 2023 as everyone was chasing for risk after a tough 2022,” said William Lam, head of Asia convertible bond trading at BNP Paribas in Hong Kong.

“Overall, we should see more volume in 2023 than 2022 for the same period.”

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