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Market weekly – Convertible bonds: multi-functional and flexible capital (read or listen)

Convertible bonds are hybrid instruments combining bond and equity characteristics. As a result, they offer some equity upside, but with bond-like protection on the downside. If we are at the start of a cycle of rising interest rates, the option investors

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Convertible bonds are hybrid instruments combining bond and equity characteristics. As a result, they offer some equity upside, but with bond-like protection on the downside. If we are at the start of a cycle of rising interest rates, the option investors in these nominal assets (bonds) hold to convert to real assets (equities) could prove invaluable.  

Skander Chabbi, head of the global convertible team, explains why this flexible form of capital is particularly suited to the current investment environment

Read the article or listen to the podcast with lead portfolio manager Skander Chabbi for the convertible bond strategy

With many financial markets focused on the prospect of rising interest rates and leading economies maybe on the brink of stagflation, it is timely to note that the duration of convertible bonds – their interest-rate sensitivity – is limited.

Unlike conventional bonds, convertibles have sources of return beyond interest rates. They include credit spreads, equity prices, and market volatility.

So in a rising rate environment, we expect equity market trends and credit to be the main drivers of performance. A gradual rise of market volatility is positive for convertible bonds. A convertible bond combines a bond and a call option (see exhibit 1). This option to buy the issuer’s stock typically increases in value when the volatility of the underlying stock rises.

Source: BNP Paribas Asset Management, September 2021

This combination provides investors with what we believe is an attractive total return profile with limited downside at times when the equity market does not perform. That is when the bond-like characteristics kick in – aspects such as the fixed coupon and the fact the bond is typically redeemed at par.

So, in the sharp and broad market downturn in February-March 2020, when the extent of the pandemic and the need for strict containment measures became apparent, the losses for convertibles amounted to only about a third of the downside seen in equity and bond markets.

More generally, when equities collapse, the performance of convertible bonds becomes more bond-like. So, as markets recovered from the slump, convertibles were quick to move in synch.

Convertible bonds – A cheap (re)financing tool

What we saw some 18 months ago was that many companies turned to convertible bonds to shore up their balance sheets. The terms for issuing equity would have been too onerous. The result was a virtuous circle – convertibles issuance improved credit ratings and narrowed credit spreads; this helped support the prices of the issuer’s equity; higher stock prices added to the attractiveness of the call options, which helped lift the convertible bonds.

The fact that stock prices were so depressed when this wave of refinancing began only added to the appeal of convertibles for both issuers and investors. Favourable interest rates were a further attraction of using convertible bonds as a cheap refinancing instrument. The embedded equity call option allows the issuer to lower the coupon so that it is cheaper to issue a convertible than a regular corporate bond.

In fact, we have even seen zero coupon convertibles being issued. Examples would include a US carmaker and a French utility, both with investment-grade credit ratings. High-yield issuers – with lower ratings – could be paying coupons of 1.25% or 1.50%. Examples of issuers would be a US airline, a US web and internet services company and an Indian telecommunications company.

To underscore the breadth of this segment further, with a market size of some USD 600 billion, recent issuers have included high-growth companies in the US tech and healthcare sector. We see this as a natural area for convertible bonds given the upside potential for their shares. In Europe, fast growers in the online delivery segment have issued convertibles, although I should point out that this area is now under pressure from rising costs and greater competition.

Overall, we believe there is a wide range of reasons for companies to issue convertibles.

A place for convertibles in many portfolios

Equally, we believe in the suitability of convertibles for many investors.

Taking the perspective of an equity portfolio manager who now faces high valuations in many markets and toppish index levels, convertible bonds can act as an alternative for a percentage of the allocation. To have some protection from equity market downside, but also keep a measure of equity exposure, they could switch into convertibles when they believe stocks have reached a high.

For fixed income managers who in the face of rising rates might want to limit their interest rate exposure, convertible bonds can be a way to reduce the duration of the portfolio given the lower interest rate sensitivity of convertibles relative to straight corporate bonds.

Looking at valuations, we believe convertible bonds are not expensive in the context of rising rates, that is, compared to the straight debt market. Furthermore, credit spreads relative to regular corporate bonds are still comparatively large, which should provide a cushion in a down market. In this respect, convertibles are adequately priced, in our view. 

Overall, we expect a similar return from convertibles in 2022 to that of equities, which we estimate to be in the 5% plus range, with a much lower volatility in the convertible bond market.

We believe the wider appeal of this segment is underscored by the broad range of investors invested in it. Investors eyeing the equity-like characteristics include hedge funds and multi-strategy funds; those attracted by the bond-like aspects include credit investors such as asset managers, insurance companies, savings banks and pension funds. Even central banks have been buying convertibles.

To sum up, we see a place for convertible bonds in equity, multi-asset and even fixed income portfolios.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. 

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).  

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Skander Chabbi. The post Market weekly – Convertible bonds: multi-functional and flexible capital (read or listen) appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.

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Government

When Will Royal Caribbean, Carnival, Norwegian Drop Vaccines, Testing?

One of the big three cruise lines just extended its covid-related protocols in the United States until the end of September.

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One of the big three cruise lines just extended its covid-related protocols in the United States until the end of September.

The cruise industry got hit by a perfect storm when the covid pandemic hit. 

For an industry vulnerable to storms in general, it was a terrible combination of events that left the industry shuttered, while hotels, theme parks, arenas, and other venues all remained closed for much less time.

That's because the United States government only has limited control over how private industry operates. 

A local municipality may shutdown industries like the way New York closed Broadway or California shut down its theme parks — but the federal government only has limited power for certain things.

When it comes to cruise lines, however, the federal government has an incredible amount of power. 

That's because all the major cruise lines including Royal Caribbean (RCL) - Get Royal Caribbean Group Report, Carnival Cruise Lines (CCL) - Get Carnival Corporation Report, and Norwegian Cruise Line (NCLH) - Get Norwegian Cruise Line Holdings Ltd. Report flag their ships outside the U.S. 

That allows the Centers for Disease Control (CDC) to regulate how the cruise lines operate.

During the pandemic the CDC made an example of the cruise industry, It shut down cruising from North American between March 2020 and July 2021, ignoring the industry's extensive efforts to show it could operate safely. 

Eventually the CDC relented, allowing limited-capacity sailings with a lot of rules beginning in early July 2021.

Now, most of those protocols have gone away as the CDC has lost its leverage with the rest of the country returning to pre-pandemic operating standards. 

The cruise lines, however, still have certain rules in place and two key ones aren't going anywhere any time soon.

Dukas/Universal Images Group via Getty Images

What Are Cruise Covid Protocols Like Now?

Royal Caribbean recently told its booked passengers that it plans to keep its current covid protocols in place through the end of September. 

Currently, Carnival, Norwegian, and Royal Caribbean all have similar Covid-19 rules

They require:

  • All passengers 12 and over must be fully vaccinated at least two weeks before sailing.
  • A vaccine card — not a digital copy — must be shown before boarding.
  • All passengers must present a negative Covid test (which must be a proctored test) taken no more than two days before their cruise. 

All three cruise lines have made masks optional while onboard. 

In addition, Royal Caribbean, Carnival, and Norwegian all operate with a fully-vaccinated crew and have procedures designed to handle when passengers or crew members show Covid symptoms during a sailing.

When Will Cruise Lines Drop Vaccine and Testing Requirements?

Many passengers and future passengers want to know how long these protocols will be in place. 

Some people who are not vaccinated want to return to cruising, while others who are vaccinated simply don't want the added hassle of proving it.

The cruise lines, of course, must balance people wanting a return to normal with other passengers who like sailing with fully-vaccinated passengers who have also recently tested negative.

Currently, Carnival, Royal Caribbean, and Norwegian all participate in a voluntary safe sailing program led by the CDC which sets testing and vaccination standards.

It's possible the CDC changes these requirements, but probably not any time soon, according to former Food and Drug Administration chief Scott Gottlieb, a physician who serves as chairman of Norwegian Cruise Line Holdings’ SailSafe Council.

 “I think that it’s likely to be a requirement that is in place through this fall and winter,” Gottlieb said. 

“I’m talking more about CDC and the policy environment. I think that the public health officials, CDC, is going to want to see what the epidemiology of this disease is when it gets to a quote, unquote, ‘normal’ state."

Gottlieb said he does not expect the CDC to make any changes until it sees a period of time where no new variants flare up. 

He said he thinks the federal agency will wait until 2023 and not even first thing next year.

“The short answer to the question is: I think this is kind of a springtime thing from a CDC policy standpoint," he said. 

"They are going to want to make a decision around this after we get through another fall and winter with covid and see if we are truly in an endemic phase with this.”

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Spread & Containment

Swiss Watch Shortage Spreads From Rolex To Cartier And Tudor

Swiss Watch Shortage Spreads From Rolex To Cartier And Tudor

A top retailer of Swiss luxury watches warns robust demand and the lack of supply…

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Swiss Watch Shortage Spreads From Rolex To Cartier And Tudor

A top retailer of Swiss luxury watches warns robust demand and the lack of supply have sparked a perfect storm of global Rolex shortages that has spread to other leading brands, including Cartier and Tudor. 

CEO Hugh Brian Duffy of Watches of Switzerland Group Plc, with a network of 171 retail stores between the UK and the US, told Bloomberg on Thursday morning that sales of Rolex, Patek Philippe, and Audemars Piguet had only "modest" increases in the retailer's 2022 fiscal year, primarily because of limited supply. He said this drove demand for other high-end brands. 

"We more than doubled our increases with them," Duffy said, citing Rolex sister brand Tudor, independent Breitling, LVMH's Tag Heuer, Swatch Group's Omega, and Richemont's Cartier. 

He said the Rolex shortage had increased so much demand for certain Cartier and Tudor models, that now those are experiencing supply issues. 

"We can't get enough Santos," he said, referring to the Cartier aviator watch, adding Tudor's chronograph models are in short supply.

Sales of Swiss watches went through the roof during the pandemic as classic high-end timepieces were in high demand as central banks worldwide pumped trillions of dollars into the financial system. Hot money had to end up somewhere, and some wound up in Rolexes and other luxury Swiss brands. 

Duffy concluded the interview by saying retail demand for Rolex, Patek Philippe, and Audemars Piguet watches outweighs supply: "Demand is just off the scale for those brands. We would love to have more of them." 

And when does this Swiss watch bubble end? Will it be when central banks spark the next global recession from aggressive monetary tightening? 

Tyler Durden Sat, 05/21/2022 - 08:45

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Spread & Containment

Let Them Eat Bugs… How Out-Of-Touch Elites Reveal Their Contempt, & What Comes Next

Let Them Eat Bugs… How Out-Of-Touch Elites Reveal Their Contempt, & What Comes Next

Authored by Nick Giambruno via InternationalMan.com,

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Let Them Eat Bugs... How Out-Of-Touch Elites Reveal Their Contempt, & What Comes Next

Authored by Nick Giambruno via InternationalMan.com,

Upon being told that the people had no bread, Marie Antoinette reportedly responded, “let them eat cake.”

These infamous words were a stark illustration of the French elite’s careless indifference to the plight of ordinary people. Moreover, they likely fueled the anger that sparked a revolution that overturned the French ruling system.

Had Marie Antoinette not been so out of touch, she might have had a better choice of words.

Although history doesn’t repeat itself, it does rhyme.

I am bringing this up because recently, modern political, financial, and media elites have made numerous “let them eat cake” remarks.

They similarly reveal how oblivious they are to the average person’s problems as inflation spirals out of control, shortages spread, the stock market crashes, and economic prospects look dimmer by the day.

Let’s look at them and examine what they could mean for the social and political environment in the future… and what you can do about it.

Example #1: Inflation Is Good

First central bankers, the mainstream media, and academia tell you there is no inflation.

Then, when inflation becomes undeniable, they tell you not to worry because inflation is only “transitory.”

Then, when it becomes apparent that it’s not merely transitory, they tell you not to worry because inflation is actually a good thing.

It’s not uncommon to see ridiculous headlines like this:

Example #2: No More Turkey at Thanksgiving

After inflation broke through multi-decade highs, it’s no longer possible to maintain the farce that “inflation is good.”

So the elite’s messaging has pivoted to ways the plebs can cope with ever-decreasing living standards.

Last Thanksgiving, it was impossible for the Federal Reserve to ignore the soaring costs of turkey. So, instead, the St. Louis branch had a helpful suggestion for those struggling—substitute delicious turkey for cheaper heavily-processed industrial sludge.

Example #3: Let Your Pets Die

Recently, Bloomberg published an article titled “Inflation Stings Most If You Earn Less Than $300K. Here’s How to Deal.”

It recommended rethinking providing medical treatment to your pets:

“If you’re one of the many Americans who became a new pet owner during the pandemic, you might want to rethink those costly pet medical needs.”

Example #4: Gas Is Too Expensive? Buy a Tesla

As gas prices skyrocket, transportation Secretary Pete Buttigieg suggests buying an electric vehicle. That way, the plebs can stop complaining and will “never have to worry about gas prices again.”

The thought of whether people could afford an expensive electric vehicle in the first place didn’t seem to cross his mind.

Example #5: Housing Is Too Expensive? Live in a Pod or Move Back In With Your Parents

With soaring prices making housing unaffordable in many big cities, living in pods is promoted.

For example, in California, a three-bedroom home that used to house a single family has been converted into a unit that includes pods for 13 people.

Similar stories are sprouting up across other cities. The media is celebrating this not as a significant downgrade but rather as an eco-friendly solution to rising housing costs.

They also recommend moving back in with your parents.

Example #6: Meat Is Too Expensive? Eat Bugs and Industrial Sludge

With inflation making meat unaffordable for many, the elite are looking to keep the plebs happy by guilting them into thinking that meat is bad for the environment.

That’s a big reason why there’s been a flurry of articles in the mainstream media condemning meat consumption and promoting cheap alternatives.

Their solution is to give the plebs fake meat made of heavily-processed industrial sludge and feed them bugs.

Bill Gates recently said: “I think all rich countries should move to 100% synthetic beef.”

“You can’t have cows anymore,” and governments can “use regulation to totally shift the demand.”

An article in The Economist notes: “We’re not going to convince Europeans and Americans to go out in big numbers and start eating insects… The trick might be to slip them into the food chain on the quiet.”

The Guardian tells us eating bugs can assuage your climate sins and that “if we want to save the planet, the future of food is insects.”

Here’s Bloomberg:

These are a couple of examples of a much broader push against meat.

Here’s the bottom line.

The elite have been informed that meat is becoming too expensive for the average person. Their answer: “Let them eat bugs.”

Conclusion

This overview is by no means a complete collection of recent “let them eat cake” statements. However, it is enough to understand what the elites think and their contempt for the average person.

These are the same people who engaged in—or closely benefited from—the rampant money printing and other policies responsible for the rising prices ravaging regular people in the first place.

And when the pain of inflation became apparent, their response has been… inflation is good… no more turkey at Thanksgiving… let your pets die… buy an expensive electric vehicle… live in a pod or move back in with your parents… and eat bugs.

Instead of looking at these examples separately, take a step back and reflect on the Big Picture they paint. That will help us better understand the social and political situation, where things might be headed, and what we should do.

With that in mind, two things seem clear.

1) The current crop of political, financial, and media elites are ensconced in a bubble, carelessly indifferent to the problems of ordinary people—much like Marie Antoinette was.

2) Anger is building up as people feel increased economic pain.

Nobody knows how the situation will resolve itself, but I think it would be foolish not to prepare yourself—and your portfolio—for turbulence in the months ahead.

*  *  *

The economic trajectory is troubling. Unfortunately, there’s little any individual can practically do to change the course of these trends in motion. The best you can and should do is to stay informed so that you can protect yourself in the best way possible, and even profit from the situation. That’s precisely why bestselling author Doug Casey and his colleagues just released an urgent new PDF report that explains what could come next and what you can do about it. Click here to download it now.

Tyler Durden Sat, 05/21/2022 - 08:10

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