Our investment philosophy is underpinned by six core beliefs, which are summarised below:
Empirical evidence suggests that convertible bonds have historically participated to a greater extent in upward stock movements than in downward movements. This asymmetric return profile effectively gives convertible bond investors an edge, as they are able to exchange a small amount of upside exposure for a relatively significant amount of downside protection. Analysis by Ibbotson Associates on US convertible bond returns (1974-2004) showed that convertibles had 70% participation in upward markets and only 52% in downward movements. An analysis by Aviva Investors on global convertible bond returns (Dec 1994-Feb 2009) showed that convertibles had 75% participation in upward markets and only 45% in downward movements.
We aim to structure our portfolio in order to maximise the asymmetric return characteristics.
Convertible markets are not fully efficient; pricing disparities exist, and these opportunities should be exploited.
Mispricing in the convertible market is not uncommon. Product characteristics and disparate investor groups create pricing inefficiencies. Convertible bond pricing is complex as it draws on a wide range of inputs. Investors will have different estimates for these price factors, which will then be processed by bespoke or customised valuation models, resulting in different pricing parameters for the theoretical fair value of any given convertible bond. Also, as with most financial markets, there is generally a lag before new information - a change in one of the valuation inputs – is absorbed into the pricing of a convertible bond.
Finally, the lack of research coverage for smaller names also leads to inefficient pricing of equity and credit risk. We believe that by combining our proprietary research with state-of-the-art-valuation models, and drawing on the expertise and knowledge of our investment team we will have a significant advantage in identifying and capturing these buying opportunities.
The scale of Aviva Investors investment operation is able to provide significant advantages to our convertible investment process. With in excess of 200 investment professionals covering equity and bond markets globally, a dedicated asset allocation team and our own in-house economists, Aviva Investors investment infrastructure is able to provide valuable insights to various aspects of our convertible bond investment process.
Further to this, the scale of our external relationships with brokers, analysts and third party researchers is able to secure us significant bargaining power and a high level of service with our suppliers. This extends to our access to new issues of convertible bonds.
The level of convertible bond issuance has a significant impact on market valuations, especially during periods of low supply. As appetite for convertible bonds is to some extent inelastic (driven by regional long-only investors) periods of low issuance (or supply) have tended to result in rich valuations. The advantage to having a global remit is that our SICAV sub-funds are able to allocate globally to the most attractive markets, whilst regional funds will not have this flexibility
Aviva Investors investment process has a strict focus on stock selection. Ensuring the quality of the underlying equity and credit is a pre-requisite to investing in any convertible issue and we have strict guidelines on the fund’s overall credit quality. For example, a fund that avoids distressed-debt-style investment opportunities as this represents a significant deviation from our primary goal of capturing asymmetric returns. While this may occasionally impact short-term performance, we firmly believe that over the long-term this is the most prudent strategy for the relevant fund.
Ultimately, if investors want access to distressed debt managers, we believe that they will prefer to do so via a dedicated mandate, so as to avoid taking any unwanted or unintentional investment risk.
Aviva Investors manages a global convertible bond arbitrage fund alongside global long-only strategies. We believe this provides a unique insight into global convertibles markets, as it ensures that our investment team considers the pricing influences of both long-only investors and arbitrage funds, each of which represent 50% of the market.