Convertibles Stage a Comeback

By ANDREW EDWARDS Convertible debt has staged an impressive turnaround in March, but low trading volumes in this niche of the credit market mean a protracted recovery could prove elusive. The key has been a snapback in the financial sector, which represents about 20% of the total market. Convertibles sold by health-care and technology companies, the other heavyweights in this market, have gained to a lesser extent. Driving the move is growing optimism that government measures aimed at shoring up banks will work. Over the past week, the government unveiled details of its new public/private partnership to buy toxic assets, while the Obama administration struck a more conciliatory tone. "A big part of it is a growing sense the government is not going to take over all of these banks," said Edward Silverstein, convertibles portfolio manager at MacKay Shields. Hope has taken convertibles into positive territory for the month and turned them around for the year. As of Thursday's close, U.S. convertibles were up 4.53% for the year to date, according to Merrill Lynch, compared with a 7.8% drop in the S&P 500-stock index. The financial sector is up 7.8% this month through Thursday, but off 7.3% for the year. Convertible bonds, a hybrid of stocks and bonds that pays investors a coupon smaller than a comparable bond but gives them the option to convert into stock at a later date, were battered when many traditional trades favored by hedge funds fell apart. This month's rebound has been driven by stock investors who were able to ratchet up prices amid low trading volumes. "It's mainly been a lack of liquidity that's driven the market up higher," said Richard Meatto, head of convertibles trading at Broadpoint Capital. "Now that [demand] has been broadened, the supply has just kind of dried up." According to TRACE data, volume is down sharply from previous years, with an average of $1.4 billion in bonds traded daily in March, compared with $2.37 billion a day in the comparable period last year. However, since the stock market turned around March 10, the bulk of those trades have been positive. Mr. Meatto said stock accounts used to "unlimited liquidity" are willing to bid up bond prices to get the convertible exposure they want. The convertibles allow the traders to participate in any stock upside while being paid, often handsomely, to wait. Company buybacks are sucking up supply and new issuance is slowing to a trickle. The U.S. market stood at $162 billion at the end of February, according to Merrill Lynch, down from $177.4 billion at the end of 2008.