Last updated on October 19, 2022
Daniel Partlow, chief risk officer at Advent Capital Management, joins the podcast to discuss convertible bonds. Partlow is a specialist in these securities, having written a book on the subject titled ‘Convertible Securities: A Complete Guide to Investment and Corporate Financing Strategies.’
- First, the basics: What are convertible bonds and how do they work? The asset class has actually been around for more than three centuries… (3:29);
- Some of the characteristics of converts include a maturity of about four to five years but with low interest rate sensitivity of much shorter duration bonds (6:42);
- A typical balanced convert will provide downside protection (via the bond floor) and upside potential through the equity participation (9:18);
- Converts have done well in inflationary environments, with less volatility than stocks (11:44);
- The default rate for converts is a fraction of high yield and leveraged loans (20:38);
- Background on the guest (24:59);
- The specter of stagflation and how converts can protect against that (27:50);
- Where might there be particular opportunities in the converts market right now? (33:07);
- Examples of individual securities that may be of interest (37:52).
More Background on the Guest
The following slides were supplied by Advent Capitaol Management.
Quick Highlights From Our YouTube Channel
Nathaniel E. Baker 0:35
I’m here with Daniel Partlow, Chief Risk Officer of Advent Capital Management in New York, we are going to talk about convertible securities, convertible bonds. This is an area of Wall Street that is not talked about very often. But it is quite interesting and spoiler alert, to incentivize those of you who may not be familiar with his asset class, which I assume is most of you. Listen, I can tell you right off the bat that they have a better track record than vanilla equities or bonds. And they combine the two, and we’ll get into that. But Daniel here is a bit of an expert on this asset class, having literally written a book called convertible securities, a complete guide to investment and corporate financing strategies. And I believe you wrote that recently, right?
Daniel Partlow 1:31
That’s right. It came out in March.
Nathaniel E. Baker 1:34
Oh, so this year, fantastic. March of this year.
Daniel Partlow 1:36
Nathaniel E. Baker 1:36
But yeah, but let’s start and maybe from a basic just with a bait, let’s cover the basics first, what are these convertible bonds? Right? How do they work?
Daniel Partlow 1:46
Sure, well a convertible is, is either a bond or a preferred stock with an option to be converted into shares of common stock. And you know, for those not familiar with them, that may sound like some sort of financial engineering wizardry that you would have heard about in The Big Short, but you know, that’s not what this is right? This is not Steve Carell Brad Pitt and Christian Bale, you know, type of of a short but, you know, that was massive, leveraging a very poor credit. Convertibles have actually been around for 300 years, funding growth and innovation. In fact, the first one was the British East India Company issued bonds, convertible into sovereign debt. And then in the first half of the 1800s convertibles were issued to finance the early railroads and western expansion. In the 1900s. They were issued to finance automobiles. By mid century, they were financing airlines, microwave ovens, you know, the 80s came around it was personal computers. In the 90s. It was the dot coms and E commerce. And you know, the asset class has a very, you know, tech orientation to it now, you know, cloud companies, social media, semis, you know, storage, you know, outside of tech, there’s biotech, FinTech, you know, Evey companies. So basically all the disruptive, transformative businesses use convertibles to finance growth and innovation.
Nathaniel E. Baker 3:23
Okay, now, why would a company choose to do a convert rather than an equity offering or bond?
Daniel Partlow 3:30
Well, there’s a number of reasons. Convertibles, typically are issued with a lower coupon, right? They do, you know, offer a coupon. Some of them are zeros these days. But, you know, there is coupon income, but from the company’s perspective, they’re really saving on interest expense, right, and they’re willing to give up their, you know, their stock, and it’s issued at a premium, a conversion premium, right. So, essentially, it’s convertible at a price, you know, 30 to 50%, above today’s stock price. So we’re essentially issuing stock at a higher price. On a deferred basis. Oftentimes, convertible issuers will get a call spread, right, as part of the deal. That’s not, you know, something that the investor is concerned with that actually comes from the investment bank that helps them to issue it. And so effectively, you know, they’re issuing stock up 100%, right, when you when you add the convert the initial conversion premium, you know, the call spread they get from the investment bank. So, while it’s diluted, it’s diluted at a much more, you know, greater value than the company has at the time of issuance.
Nathaniel E. Baker 4:53
Right. Okay. So you get this this bond, I guess, a convertible bond we’re talking about, and it hasn’t matured. It wasn’t typical maturity, like two or three years?
Daniel Partlow 5:03
Well, it has a maturity of, you know, four or five years. Yeah, and one interesting property of convertibles is they, they have a maturity of four or five years, but they, they actually have the interest rate sensitivity of a much shorter bond, right. So when I think of, you know, high yield, for example, having, you know, duration of about four years, that means, you know, for every 1%, interest rates go up, right, high yield would decline about 4%, or investment grade corporates, it’s more like seven to eight, right? So every 100 basis point increase in interest rates, it’s going to lose seven or 8% of its value. convertible bonds, even though they have a comparable term to high yield, they have much less interest rate sensitivity. And the reason for that is that, you know, the bond portion has duration, but the option that’s embedded in the convertible has negative duration, it actually increases in value as interest rates rise. So, you know, that’s, that’s one of the interesting features that makes it attractive to fixed income investors. Sure.
Nathaniel E. Baker 6:12
And then you get this guess this conversion of the premiums to say you have a stock trading at 100. And you say typical premium is like, what 30%. So they have to say it gets to 130. If it gets to 130, at any point, is it at any point in the in the for the duration of the bond or is abide, it doesn’t have,
Daniel Partlow 6:31
you know, the Bond could be converted at at any point. But typically, it doesn’t make sense to do the conversion, you know, prior to maturity, right? Because that option has value right up until the very end. So, you know, if you’ve, if you’ve made your money and you decide, it’s time to get out, you sell it rather than converting it, right. There’s are very few corner cases, you know, where where we would actually exercise something a little early, but, you know, it’s a very rare event.
Nathaniel E. Baker 7:02
I see. So people don’t generally hold these and for duration to pick up the equity. Okay, it’s all done?
Daniel Partlow 7:08
Well, certainly you can, the thing is, not all converts are created equal, right, they are basically a convertible, some of them are very much like equities, some of them are very much like bonds, and some of them are somewhere in between. Right. So if you have bought a convertible bond, that’s what we call balanced, you know, somewhere in between, you know, the equity and bond world, you like having the positive asymmetry that you like having the downside protection of the bonds, the stock price goes down, you know, you’ve got you’ve got your, your bond floor, we’ll call a bond floor, that protects your investment. And yet, if the stock price goes up, you’ve got the equity participation, right, you know, you’ve you’re more likely to convert into the equity and, but what happens sometimes is that the convertible issuer will issue a convert and the stock price will just go up and up and up, like like Tesla, for example, right, they issued a number of convertibles and their stock price, you know, went through the there was some volatility there of course, but, you know, generally went straight up and those convertibles basically became what we call equity surrogates. Right, they became you know, they would trade one for one with the, you know, with the underlying equity right. And then there are some convertibles that were the you know, equity prices declined you know, the convertible is sitting you know, right on its bond floor, what we call bond floor and, you know, if the equity price declines enough that it becomes unlikely that it will ever you know, be exercised, then, you know, then that trades like a bond so, so convertible issuers, investors will trade out of a convertible if it doesn’t have the properties that they’re looking for,
Nathaniel E. Baker 9:06
okay, do these things trade publicly or do you need to have a good deal of a can retail investors access them?
Daniel Partlow 9:13
They can certainly through their, you know, through their broker. So, but, you know, we typically serve institutional investors or retail investors through a platform. And I should also mention that we do have, there are funds that trade, both open ended and closed ended convertible funds, we have to manage a closed end fund called ADK, which has convertibles as well as some high yield
Nathaniel E. Baker 9:46
equity. Okay, so talk to me now, because it sounds like yeah, these are these are pretty hybrid products, if you will, and, but you say they usually do well during an inflationary invite armament and why is because we don’t do well, obviously. And then equities well?
Daniel Partlow 10:06
Well, yeah, let me just give you a few comments about their long term, return, you know, how they’ve done this year, and then we can talk about some specific inflationary environments. So, you know, convertible returns, the asset class has been around forever, but we actually have return information for the entire asset class back to 1973. Right, so the indices began about 1987. But there were, you know, studies done by Ibbotson associates that basically had the annual returns. And so, you know, we can plot the return of convertibles over time. And, and basically, It’s neck and neck with the s&p 500, since 1973, but with only a portion of volatility, right. So it’s not going up quite as much in the in the up years, not down quite as much in the down years. It’s kind of a, you know, a win by not losing type of strategy. So, but very comparable returns, you know, the asset class as a whole to the s&p 500.
Nathaniel E. Baker 11:11
Okay, that makes sense. That makes sense. But so where does the inflation protection come from?
Daniel Partlow 11:17
Right. So, you know, we did a study on inflation, and I sent you a slide, which you can put on your website, but, you know, for your listeners, let me just tell you, we looked at five periods of inflation from 1973 to 1985, you know, when peak CPI had 14.8 1987, and 1991, CPI had 6.3, we looked at 99 to 2000. That was more of a wealth effect type of inflation, the CPI only hit 3.8, but it was a, you know, a spike in it. Oh, 5208 Right. So, just prior to the financial crisis, inflation actually hit 5.6%. And then, you know, 2000 2022 Well, you know, basically, we did the analysis back in May at a point, you know, 8.6. And so, you know, a little higher than that now, and, in these five periods, convertibles outperformed both equities and core fixed income, right. So convertibles, you look at that entire all of those five periods, they returned 10.8% versus the s&p 10.3%. Right. And core fixed income bonds came in about 7.1%. So really strong outperformance when you look at, you know, entire inflation cycles, right. So, so, you know, generally the inflation is not a bad thing for convertibles, relative to other asset classes. Right. Equities
Nathaniel E. Baker 12:58
might, like I said, inflation is bad for bonds. Right? Please don’t always keep pacing.
Daniel Partlow 13:04
Right. So, you know, for bonds, convertibles have less interest rate sensitivity, as I mentioned before, you know that that equity option actually increases in value with rising interest rates. And so that keeps the exposure to rising interest rates low. The other thing is, you know, sometimes rising interest rates are associated with robust growth. Right. And so when you have robust growth, you know, rising interest rates is going to crush your treasuries. But your equities are usually doing pretty well. And convertibles participate in that, you know, upside?
Nathaniel E. Baker 13:44
Right. Yeah. Very interesting, kind of surprising maybe that there hasn’t been more, more interest in the asset classroom, especially from REITs.
Daniel Partlow 13:52
We call it an overlooked asset class, it really is, you know, overlooked by a lot of investors it is, you know, it’s not quite as big as high yield, it’s not quite as big as leveraged loans. Both of those are, you know, a little over a trillion size, but the convertible asset class has really grown a lot, you know, over the last couple of years record issuance and 2020 and 2021. And so, you know, it’s, it’s, it’s hovering, you know, between 600 and 700 million billion now,
Nathaniel E. Baker 14:26
are there distressed converts or is this mostly investment grade companies,
Daniel Partlow 14:30
there are certainly some distressed converts. In fact, you know, the convertible issuers tend to be more growth oriented, right. And so, you know, you have a lot of tech companies, but when COVID hit, you know, March April May of of 20. You also had a lot of consumer discretionary type companies coming to market. You know, the cruise lines, the airlines, the theaters You know, basically they were shut down. And, you know, they needed bridge financing, you know, to get through COVID. And, you know, the high volatility of their underlying equities allowed them to issue, you know, convertibles, and they did very well, right? Through, you know, through the COVID cycle those, you know, those those convertibles did well. So, yeah, those are, you know, some of the different kinds of convertible issuers,
Nathaniel E. Baker 15:35
well, that’d be a typical time to ensure converts when you have this need for bridge financing or is it just all across the board?
Daniel Partlow 15:44
It is, you know, sometimes the Convert market is open, but I will say that, you know, convertible, issuers tend to focus on financing through convertibles. Right, so, for over half of a convertible issuers, the convertible debt is the only debt on the balance sheet. Right? And for the, you know, I don’t want to call them distress, but for the more defensive, lower delta convertibles, that number is actually 70%. Right? So, you know, when when the stock has gone up, and the equity is appreciated, and the market cap is up, you know, the convertible doesn’t behave as much like a bond as it starts to behave more like the equity. But for those convertibles, where the, you know, where the equity has come down, it’s behaving more like a bond credit becomes, you know, a concern. And, and, you know, it’s good to know that 70% of those bonds, it’s the only debt on the balance sheet. And those issuers are typically paying little for interest expense. Right. And, and oftentimes, they you know, they still have the cash, right, and maybe there’s a little cash burn, maybe they’re cashflow positive. But, you know, that’s, that is a reason, you know, for for optimism, you know, I don’t want to speculate too much on what the future holds. But one of the things that, you know, that we look for, is, you know, we have a really strong fundamental credit process here. And, and so, you know, we look for the kinds of companies that have cash on the balance sheet, free cash flow positive. And, and, you know, and with convertible debt being the only debt on the balance sheet, you know, there’s, there’s reason to think that a lot of our Convertible issuers will will do fine, even in a recessionary type scenario.
Nathaniel E. Baker 17:48
Yeah, and it says here, that the default rate is basically a fraction of what it is for high yield and leveraged loans, right, yeah, over over a
Daniel Partlow 17:57
long period of time, you know, convertible issuers tend to have about a 1% default rate in comparison to 3%. For high yield, and, and leveraged loan issuers. You know, now, I should note that oftentimes convert, you know, one of the reasons issuers like to issue convertibles is that they don’t have to go out and get a rating. Right. And, and so, you know, most convertibles do not have a public rating, we rate everything we invest in we, you know, we know what the credit quality is. And, you know, so in general, about 75% of the asset class is, you know, high yield, right. So with a credit quality of, you know, double beat or below, and about 25% would be considered investment grade, if it did have a rating, right. So, even even though, you know, maybe a quarter of the asset classes, investment grade, and three quarters is, you know, speculative grade, it has a very low default rate, you know, taking the credit quality into consideration. So, you know, that’s, you know, speaks to the, you know, to the underwriting in the asset class.
Nathaniel E. Baker 19:18
Yeah, very interesting. All right, Daniel Partlow, I want to take a short break and come back and ask you some more about your background. And more importantly about opportunities right now, in converts, and some areas that you and your firm might see might think are interesting. Before we do though, if you are a premium investor, do not touch the dial, you will not get the break. We’ll be right back. In fact, we already are. Welcome back, everybody here with Daniel Partlow. of Advent capital, Daniel. This is the segment of the show, where we ask the guests, guests to talk a little bit more about themselves, personally and professionally. How they came to The station in life how they started investing in the first place. So curious about your background and how it took you to converts. So go ahead.
Daniel Partlow 20:07
Right, okay. Well, you know, I have an economics degree from the University of Missouri, a master’s in International Management from Thunderbird graduate school. That’s where I got interested in risk management, they had a program that had been developed at INSEAD. That’s the big European Business School. And, and so I focused on that by doing working as a TA for the risk management program for two semesters. So you know, then in the 90s, I did risk management consulting, primarily for corporate treasury, right? Analyzing foreign exchange rate and interest rate risks, writing, risk management, policy statements, putting systems in place. You know, from there, I got hired at AIG, right to work in their risk management department in the early 2000s, implementing risk management systems for the basically about 600 billion in insurance investment assets that they managed. And then, you know, after I left there, I went to Stanfield capital that was a clo and leveraged loan manager and served as their Chief Risk Officer. And that’s where I wrote out the 2008 financial crisis. So, you know, I should mention that we managed to get through it with about a one and a half percent default rate, in comparison to about 11%, for the for the overall asset class. So we, we did a good job of of managing risk there. I joined Advent in 2011. And I’ve built out the risk platform here, I’ve had the opportunity to work with really the leading minds in the convertible asset class. And that gave me the training that I needed to write what I think is the authoritative book on the asset class, it’s really the, you know, the first book in a long time, there are some good books written in the 90s. But we talked about, you know, the last 20 years, you know, the performance, the changes, you know, that the asset class has gone through, just in terms of the structure of the convertibles and, you know, wrote that, together with our president and CIO, Tracy Maitland, and a retired Portfolio Manager, Barry Nelson, manage one of our more successful portfolios, you know, through the early 2000s.
Nathaniel E. Baker 22:34
And you talk about, you know, that we’ve talked about the benefits of these converts a lot. And I’m wondering if they, there’s any kind of disaster hedge type of maybe not disaster, but one of the things that you read a lot about now, and you’ve heard a lot about a stagflation, which is obviously different from inflation, because you get lower growth, as well as inflation. So we kind of had that in the 70s. Round, but not really, since you’re not at all set. So, right. Have you studied that at all? And,
Daniel Partlow 23:04
yeah, basically, there were, you know, two periods of stagflation in the 70s and 80s. You know, the first was 73 to 75. You know, and the second one was, you know, 80 to 82. So, that, you know, there were several periods of negative GDP during that, during those two timeframes, couple of periods of of growth within there, but overall, it was, it was considered a period of stagflation. You know, there are annual returns of convertibles during those periods of time. So, you know, we can look at those and say, Okay, well, how did they do during stagflation? And to just give you an idea, you know, the s&p 500 from 73 to 75, was down about 5%. The NASDAQ was down about 17% convertibles were up 1%. Right. So convertibles did their job and more during that first period of stagflation. And then the second period of stagflation from 80 to 82. You know, it was there was a lot of periods of declining growth, but you also had inflation coming down from the peaks, right. So, if there was high inflation, but on the way down, and, and as a result of that, you know, the s&p was actually up 15%. You know, during during that and these are annualized returns, I should mention, the NASDAQ was up 15%. The Russell 2000, which, you know, came into existence in 78. You know, small caps was up 17%. But convertibles were 20%. Right. So, so beating all of those equity asset classes, so, you know, just using his history as a, you know, analogy, you know, I think there’s reason for optimism we have had high and rising inflation but You know, there are some signs that it’s cresting. And and when you have inflation starting to come back down again, that that does tend to be a positive for equities and convertibles.
Nathaniel E. Baker 25:13
Interesting any idea why that is? What is there any specific feature of converts that might help?
Daniel Partlow 25:20
Well, you know, convertible issuers tend to be growth oriented. Yeah. Right. And even though the convertible structure has very low interest rates, duration, I think one of the things that the market has observed this year, is that growth, equities tend to have an an interest rate duration to them, right? rising interest rates, you know, if you can be have positive earnings, but if you have a high growth rate, more of those earnings are out in the future. Right. And so just like, you know, a long term bond, you know, that, you know, gets its principal back in 10 or 20 years, you know, when you have rising interest rates, at tends to be long for, you know, bad for long duration, bonds, right, because they get discounted back at a higher rate. And, you know, I think growth, equity has suffered, you know, some somewhat the same effect, right, because more of the of the earnings, because they’re growing at such a high rate, a higher percentage of their future earnings, or, you know, in the more medium and long term. And so they get this kind of back, you know, I think that that’s what’s going on there. So, the growth equities have, you know, have suffered with higher interest rates, but as interest rates stabilize, right, there’s less of a concern about, you know, that duration effect. And, you know, growth equities can go back to their job of outperforming right, which, which they have done, you know, basically for the last 20 years,
Nathaniel E. Baker 27:08
if they survive, I mean, there is a, we did have that period from 2000. To what about 2005 or later, or growth NASDAQ whatever?
Daniel Partlow 27:18
Oh, you know, absolutely the, you know, the.com bubble burst was, was, was a period in which those overvalued companies, you know, got revalued downwards. But as I mentioned, convertible issuers tend to have very low interest expense that converts the only debt on the balance sheet. And so, at least for a really significant portion of the asset class, we think that there’s, you know, strong reasons to be optimistic about their long term survival.
Nathaniel E. Baker 27:52
Okay. And that brings us to the present day and what you think, where you think there might be some opportunities, but the understanding here that we’re not dispensing investment advice, but yeah,
Daniel Partlow 28:04
right. Well, well, let me just say, you know, how things have gone so far this year, right, this has been a really difficult year, across the board, right. It’s rare when you have positive correlation between stocks and bonds. Right. Typically, typically, you know, the reason the blended portfolio, the, you know, the 6040 is is such a popular concept is that, you know, when equities decline, you know, longer duration bonds tend to appreciate and so, you know, serves to offset. That hasn’t happened this year. Right. And so it’s been a difficult year, but you know, there are pockets of convertibles that have done really well. The energy sector convertibles are up 26% on the year, right materials are up 6% and investment grade plain vanilla convertibles are up three and a half percent. Right. So that’s much better than the investment grade corporate bonds that are down 13 and a half percent right 1700 basis points difference between, you know, the convert and the straight bond version, right or long term Treasuries are down 24%. Right. So that’s that’s kind of the backdrop. Now, overall, year to date. As of last night, the V zero a zero convertible index was down about 15%. It was about a percent better than the s&p 500. Right. As I mentioned, convertible issuers tend to be more growth oriented. So you know, probably a better comparison is against the NASDAQ. And that’s down 24%. Right. So convertibles are really protected on the downside, you know, relative to you know, growth equity and their underlying equities, you know, balance convertibles, which are the convertibles that have kind of To moderate Delta they sit in between the the equity surrogates and the in the more busted defensive bonds. You know they’re a little bit better. They’re down 14%. Right. Now, let’s compare that to the long run. Since 1998, the s&p is returned about 7% annualized. The NASDAQ about 8.4%, annualized. Well, the V zero a zero convertible index also comes in at 8.4. Right. Same return as the NASDAQ, but with 42%, less volatility than the NASDAQ. Right. So the NASDAQ has had vol of about 23% per year. Right. So just a lot more swings up in that compares to 13% for convertibles. Right. So one thing, you know, institutional investors like to look at is the Sharpe ratio, how much did I earn, you know, over and above the risk free rate relative to the amount of volatility I went through. And, you know, convertibles have had much higher Sharpe ratios. In fact, you know, those numbers I just gave you that results in about a 73% Higher Sharpe ratio for convertibles than for the nest. And, you know, you can look at sub sectors within convertibles, you know, different different sectors or themes, and there is a growth convertible index. And if we compare that to the s&p growth, or the Russell 2000 growth, right, since 97 growth, convertibles are up 14 and a half percent, versus eight and a half percent for the s&p and seven and a half percent for the Russell growth. Right. So it’s a really good way to play growth is is essentially what I’m saying you tend to get the more volatile growth names, but in sort of a protective wrapper of the convertible. And and that allows you to kind of win by not losing in the down periods, and then you know, participate acent, you know, with positive asymmetry, you know, in more of the upside.
Nathaniel E. Baker 32:09
Is there an ETF that tracks that converts?
Unknown Speaker 32:13
Yeah, well, you know, we have the closed end fund AVK, which is mostly converts, but, you know, there’s the CWP.
Nathaniel E. Baker 32:24
Okay, yeah, right. Okay. All right. And what about any individual securities that you think are interesting?
Unknown Speaker 32:30
Well, I’ll give you a couple of examples. So, you know, I’m, I’m the chief risk officer here, I’m not the portfolio manager, I’m not the head of research. But, you know, just to give you an idea of a couple of, you know, bonds that we have, in the asset class, a snap, right, Snapchat, social networking, you know, popular among youth, they just announced to, you know, 20% layoff. So as an $18 billion market cap, you know, it’s expected to have positive EBIT da, this year. There’s a convertible bond, you know, at 95, right, so trades at a discount to par, it has delta in the low 20s. That means it’s going to participate in about 20% of the equity sensitivity. But you know, with the bond at 95, as long as the company doesn’t go bankrupt, you got a positive rate of return, you know, back to maturity, because you’re gonna make part maturity in the downside scenario. And yet, you’ve got a 20% participation in the upside. And because there is positive asymmetry and convertibles, that, that 20 Delta is only going to grow over time, you know, as as the equity climbs, so a lot, a lot of upside opportunity, in a bond, like snap, with limited down limited downside. And then, you know, at the other end of the spectrum, you’ve got a company like Workday, that’s, you know, enterprise cloud based applications for companies. They have a $42 billion market cap, one and a half billion of EBITDA, I’m sorry, EBIT, right. And they have a convertible outstanding trades at 111. Alright, so just 11% of, you know, above par, and it’s got a Delta of 85, which means it’s kind of participate in 85% of the movement of the underlying equity. But really strong asymmetry. Right. So so, you know, if the equity goes up that 85 could go to 100 very quickly and could, you know, capture most, if not all the upside, but because it’s at 111. You know, it’s unless it defaults, it’s not going to go below 100. So there’s very limited downside in A bond like that. So, you know, those are a couple of examples. One, have a lower equity sensitivity bond might be a good investment for a fixed income investor, right. And we do have, you know, investors that are looking for alternatives for their fixed income portfolio, and they look at low delta convertibles as an option. And then you also have equity investors that are looking for, you know, a little bit more protection. And they might participate in a bond like this, you know, we’re more balanced convertible type strategy, where, where they’ve got some downside protection, but the opportunity to capture most, if not all of the upside.
Nathaniel E. Baker 35:47
I mean, to ask it, where on the capital structure typically to these converts fall? Like, is there additional protection over equities? Are they?
Daniel Partlow 35:55
Yes? Well, you know, they’re senior to the equities, as I mentioned, you know, over half of convertible issuers is the only debt on the balance sheet. So, you know, there’s not a really extensive capital structure in a lot of these companies. That doesn’t mean they’re, you know, they’re all small cap companies, there’s, you know, as many you know, large cap and medium cap, you know, is there a small cap, so, you know, a really good representation, everything from, you know, from from Twitter, and, you know, and Tesla and, you know, so So, yeah, it does sit above equity. And, you know, it will be junior to some secured bonds or
Nathaniel E. Baker 36:42
Sure, yeah, very interesting. All right. Daniel, why so have you at seeing how you are a Risk Officer, I’d like to ask people what it is that they are concerned about most what keeps them up at night, whether literally or proverbially. So, yeah. What is there anything there that that comes to mind? Well,
Daniel Partlow 37:05
I tend to, you know, have some personal concerns is not necessarily the, you know, the views of my company. But, you know, as the Risk Officer, I do have to think about the macro environment. You know, I am concerned about what is going on in Europe, you know, the potential for the impact of higher energy prices on, you know, production over there, you know, the potential for increasing interest rates, you know, more a more hawkish fed, right, so those are, those are things that, you know, could weigh on the economy in general. You know, those are, those are the kinds of things that we take into consideration when we put together our scenario analysis and think about the upside and the downside of our portfolios.
Nathaniel E. Baker 38:00
All right, that’s it. That’s it, maybe on a scale of one to 10? How would you how concerned are you right now, we’re gonna call it August of 2008, would have been 10. And January of 1989, zero?
Daniel Partlow 38:13
Well, you know, it’s my job to be more of the pessimist. You know, in the show, even though I tend to be more of an optimist, naturally, you know, it’s my job to look for the so, you know, on a scale of one to 10, with 2008, being an eight, you know, I would say maybe I’m a four or five, oh,
Nathaniel E. Baker 38:35
that doesn’t sound terrible, especially if you’re a pessimist. Cool.
Daniel Partlow 38:38
You know, there’s one other aspect of the convertible asset class I haven’t mentioned yet, and I think it’s really interesting to consider and that is, what is called convertible arbitrage. Yes. And convertible arbitrage is a strategy where you own a convertible bond long, and then you go short, the stock against it, right. So if you own let’s say, a million dollars of of the convert, and it’s got a equity sensitivity, or a Delta of 50. Right. So that means you’ve got to be short, about $500,000 worth of stock. Now, why would you do that? Well, you know, why, why, why just, you know, buy the bond and then and then short all of the equity participation out with the bond has positive asymmetry, right, it’s going to participate in more of the upside and less of the downside because the bond floor, right, and, and so and you’re going to be hedged against loss if the if the stock price goes down, but you know, you’re you make money, the more movement in the underlying equity there is. And so it’s a strategy that’s actually called a long volatility strategy. Right. And, and it tends to do pretty well. You know, on a relative basis when you’ve got, you know, a big market Fallout like this. So so the convertible ARB strategy is, is something that institutional investors often consider as a hedge against future. volatility.
Nathaniel E. Baker 40:20
Interesting. Yeah, that’s, I did study that a little bit from my hedge fund travels. But it’s not. I mean, there are some hedge funds that do it. But not all that many that have it as a dedicated strategy. There’s some there out there,
Daniel Partlow 40:32
it used to represent about 70% of the convertible asset class, but today, it represents maybe only, you know, 30%. So it’s, you know, it’s it’s much less prevalent than it used to be, but it’s still completely valid. You know, strategy is worth consideration in, you know, a choppy, volatile market like we
Nathaniel E. Baker 40:57
have today. Well, this is very interesting, Daniel, thanks for joining us. And thanks for providing this these insights. These are, give it definitely gave listeners a lot to think about, and to research some more. And speaking of which, I will include a link to the book into your website. And as far as other ways to find you. Are there any Are you active at all on social media? Maybe anything?
Daniel Partlow 41:23
Yeah, sure. I have a LinkedIn profile. You know, I’m glad to accept people’s links. And yeah, I mean, if you’re, if you’re interested in the asset class, you think there’s some value in it. I do highly recommend the book, convertible securities, complete guide to investment and corporate financing strategies. Oh, and by the way, there’s a chapter specifically for CFOs. And why they should be considering, you know, convertibles in their capital structure if they’re not already. So it’s, it’s both for investors and issuers.
Nathaniel E. Baker 41:56
Cool. Very good. Awesome. Well, thank you, Daniel, for joining us today. Thank you all for listening. And with that, we look forward to speaking to you again next time.