Credit Investments Group

It is generally assumed that the end of the ongoing rate hike cycle in key developed markets is either already behind us or not too far off. With this in mind, many investors ask themselves how to optimally position their portfolios for the new environment. We looked in the rearview mirror to examine how convertible bonds performed during such periods in the past. Since 1994 (when the Refinitiv convertible bond indices were launched), we identified four such cycles prior to the current one. The US Federal Funds target rate was used as our reference point. The following four dates correspond to the last rate hikes from the Fed during those cycles: February 1, 1995; May 16, 2000; June 29, 2006; and December 19, 2018. On some occasions, rates started retracing their earlier moves relatively quickly, while in others (such as in 2006) it took longer for rates to start declining again. In the interest of consistency, we looked at fixed time horizons following the end of a rate hike cycle, starting with six months as shown in the graph below.

Chart 1: Development of the federal funds target rate (mid point) and the period following the day of the last hike

The federal funds target rate and the period following the day of the last hike between 1994 and 2023: since 1994 (when the Refinitiv convertible bond indices were launched), there were four periods following the ongoing rate hike cycle (prior to the current one). The last rate hikes during those cycles took place on: February 1, 1995; May 16, 2000; June 29, 2006; and December 19, 2018. On some occasions, rates started retracing their earlier moves relatively quickly, while on other (such as in 2006) it took longer for rates to start declining again.
Source: Bloomberg

The federal funds target rate and the period following the day of the last hike between 1994 and 2023: since 1994 (when the Refinitiv convertible bond indices were launched), there were four periods following the ongoing rate hike cycle (prior to the current one). The last rate hikes during those cycles took place on: February 1, 1995; May 16, 2000; June 29, 2006; and December 19, 2018. On some occasions, rates started retracing their earlier moves relatively quickly, while on other (such as in 2006) it took longer for rates to start declining again.

Analyzing convertible bond performance using the Refinitiv Global Bond Index and subindices

As proxies for convertible bond performance, we used the Refinitiv Global Convertible Bond Index (Global CBs) together with its subindices Global Focus, which represent the balanced/convex subsegment as well as the investment-grade (IG) subsegment, all in USD hedged.

Strong short-term performance aligned with expectations

With the caveat that we only have four observation periods to work with, convertible bonds tend to perform well in absolute terms. In a relative context, the performance of CBs was somewhere between that of equities and bonds. Thus, we can conclude that in the short term, convertible bonds behave broadly as expected in a bond/equity paradigm.

Table 1: The performance of convertible bonds in the context of equities and bonds in a six-month total return comparison

End of Fed Hike Cycle +6 Months Performance

End of Fed Hike Cycle +6 Months Performance

Period 1
01.02.1995
01.08.1995

Period 1
01.02.1995
01.08.1995

Period 2
16.05.2000
16.11.2000

Period 2
16.05.2000
16.11.2000

Period 3
29.06.2006
29.12.2006

Period 3
29.06.2006
29.12.2006

Period 4
19.12.2018
19.06.2019

Period 4
19.12.2018
19.06.2019

Average

Average

End of Fed Hike Cycle +6 Months Performance

Global CBs

Period 1
01.02.1995
01.08.1995

12.44%

Period 2
16.05.2000
16.11.2000

-4.11%

Period 3
29.06.2006
29.12.2006

10.90%

Period 4
19.12.2018
19.06.2019

10.48%

Average

7.43%

End of Fed Hike Cycle +6 Months Performance

Global Focus CBs

Period 1
01.02.1995
01.08.1995

12.12%

Period 2
16.05.2000
16.11.2000

-0.78%

Period 3
29.06.2006
29.12.2006

11.44%

Period 4
19.12.2018
19.06.2019

7.14%

Average

7.48%

End of Fed Hike Cycle +6 Months Performance

Global IG CBs

Period 1
01.02.1995
01.08.1995

13.05%

Period 2
16.05.2000
16.11.2000

-3.91%

Period 3
29.06.2006
29.12.2006

9.74%

Period 4
19.12.2018
19.06.2019

6.11%

Average

6.25%

End of Fed Hike Cycle +6 Months Performance

Global Equities

Period 1
01.02.1995
01.08.1995

16.36%

Period 2
16.05.2000
16.11.2000

-8.40%

Period 3
29.06.2006
29.12.2006

15.02%

Period 4
19.12.2018
19.06.2019

15.54%

Average

9.63%

End of Fed Hike Cycle +6 Months Performance

Global Bonds

Period 1
01.02.1995
01.08.1995

8.92%

Period 2
16.05.2000
16.11.2000

5.36%

Period 3
29.06.2006
29.12.2006

4.51%

Period 4
19.12.2018
19.06.2019

5.90%

Average

6.17%

Historical performance indications and financial market scenarios are not reliable indicators of current or future performance.

Six-month total return comparison for five indices post Fed hike cycle. Ticker symbols: Global CBs: UCBIFX01; Global Focus CBs: UCBIFX02; Global Inv Grade CBs: UCBIFX04; Global Equities: NDDUWI Index; Global Bonds: LEGATRUH; Source: Bloomberg

The table shows the performance of convertible bonds versus equities and bonds in a six-month total return comparison - in the short run, convertible bonds behave broadly as expected in a bond/equity paradigm.

Long-term perspective reveals favorable characteristics of convertible bonds

What is even more interesting, however, is how the results change if we expand the observation period beyond the rather short six-month time horizon. What we find is that longer observation periods tend to favor convertible bonds. If, for example, a 24-month period is used, the results look as follows:

Table 2: The performance of convertible bonds in the context of equities and bonds in a 24-month total return comparison

End of Fed Hike Cycle +24 Months Performance

End of Fed Hike Cycle +24 Months Performance

Period 1
01.02.1995
01.02.1997

Period 1
01.02.1995
01.02.1997

Period 2
16.05.2000
16.05.2002

Period 2
16.05.2000
16.05.2002

Period 3
29.06.2006
29.06.2008

Period 3
29.06.2006
29.06.2008

Period 4
19.12.2018
19.12.2020

Period 4
19.12.2018
19.12.2020

Average

Average

End of Fed Hike Cycle +24 Months Performance

Global CBs

Period 1
01.02.1995
01.02.1997

37.57%

Period 2
16.05.2000
16.05.2002

-10.96%

Period 3
29.06.2006
29.06.2008

11.58%

Period 4
19.12.2018
19.12.2020

55.57%

Average

23.44%

End of Fed Hike Cycle +24 Months Performance

Global Focus CBs

Period 1
01.02.1995
01.02.1997

37.52%

Period 2
16.05.2000
16.05.2002

-9.45%

Period 3
29.06.2006
29.06.2008

10.54%

Period 4
19.12.2018
19.12.2020

37.48%

Average

19.02%

End of Fed Hike Cycle +24 Months Performance

Global IG CBs

Period 1
01.02.1995
01.02.1997

36.73%

Period 2
16.05.2000
16.05.2002

-7.50%

Period 3
29.06.2006
29.06.2008

9.66%

Period 4
19.12.2018
19.12.2020

22.07%

Average

15.24%

End of Fed Hike Cycle +24 Months Performance

Global Equities

Period 1
01.02.1995
01.02.1997

40.76%

Period 2
16.05.2000
16.05.2002

-26.24%

Period 3
29.06.2006
29.06.2008

11.79%

Period 4
19.12.2018
19.12.2020

46.01%

Average

18.08%

End of Fed Hike Cycle +24 Months Performance

Global Bonds

Period 1
01.02.1995
01.02.1997

25.17%

Period 2
16.05.2000
16.05.2002

17.11%

Period 3
29.06.2006
29.06.2008

10.34%

Period 4
19.12.2018
19.12.2020

14.26%

Average

16.72%

Historical performance indications and financial market scenarios are not reliable indicators of current or future performance.

24-month total return comparison for five indices post Fed hike cycle. Ticker symbols: Global CBs: UCBIFX01; Global Focus CBs: UCBIFX02; Global Inv Grade CBs: UCBIFX04; Global Equities: NDDUWI Index; Global Bonds: LEGATRUH; Source: Bloomberg

The table shows the performance of convertible bonds versus equities and bonds in a 24-month total return comparison - longer observation periods tend to favor convertible bonds

Global convertible bonds in particular but also to a large degree the global focus subsegment outshine both equities and bonds, on average. Of course, a substantial portion of that relative outperformance is attributable to 2020, which was an exceptionally strong year by all standards. One could also argue that four observation periods represent mere anecdotal evidence and not empirical evidence. Yet, we find the results encouraging and believe they are worth highlighting. They also deserve additional monitoring and analysis in our view.

An asset class to keep on the radar

It is still too early to say whether the end of the current rate hike cycle has already been completed or whether we still have one or two hikes ahead of us. In either scenario, however, the inflection point in the direction of interest rates and – with it – the period when convertible bonds start asserting themselves should not be too far ahead in the future.

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