Chinese curbs on stock and regular bond sales are driving record issuance of convertible notes. Buyers of the hybrid securities are being rewarded.
No 1 ranked E Fund Stable Value Bond-A returned 10.6% so far in 2017, with 52% of its assets invested in convertible debt, according to data disclosed by the fund.
 Chang Xin Convertible Bond Fund placed No 2 with returns of about 9%. It had 96% of its assets in the hybrid securities.
Underpinning the rally is a rising Shanghai Composite Index, which is up 4.9% this year, and if Morgan Stanley is right, will increase another 14% to 3,700 by June 2018. Regulatory restrictions on shares and straight bond sales as China reins in debt helped drive record convertible issuance so far this year.
“With rising issuance, convertible bonds will become an asset class that investors can no longer ignore next year, and it will be the source of extra return for many of them,” Zuo Dayong, a fixed-income analyst at Industrial Securities Co said in an interview. Zuo believes the convertible bond rally still has legs, as China’s equity market is on an upward trend.
Borrowers are preparing to sell 88 convertible notes totalling 258bn yuan ($39bn), according to Guosen Securities Co. That will add to the 53bn yuan of such securities issued so far this year, according to Bloomberg-compiled data. Hainan Airlines Holding Co plans to sell 15bn yuan of the notes, while China Citic Bank Corp is gearing up to issue 40bn yuan.
At present, outstanding yuan-denominated convertible bonds total just 122bn yuan, or 0.6% of all active local corporate bonds. 
Convertibles typically allow borrowers to raise funds at a lower coupon than for straight notes and if the issuer’s stock price rises, investors can profit by swapping the notes for shares.
Chinese currency convertible notes have handed investors a 4.8% profit so far this quarter, with the S&P China Convertible Bond Index of yuan-denominated notes on track for its best quarterly performance since the end of 2015. That beats an average return of 1.2% for 377 bond funds that are at least three years old and have assets of more than 100mn yuan, according to data compiled by Bloomberg. “There’s been a significant increase of companies seeking convertible bond ratings, which reflects a greater desire to sell those securities, as well as the strong market demand for them,” said Liu Hongtao, head of industrial and commercial ratings for United Ratings in Beijing.
After a two-month gain, some investors find the prices for some convertibles expensive. Zhang Yongzhi, portfolio manager at Huashang Fund Management Co, parent of the Huashang Stable Double Profit Bond Fund, this year’s fourth best-performing fund, says valuations are a bit stretched now with the underlying share price of some notes needing to more than double to allow conversion.
“The key risk for CBs is the volatility in the underlying shares,” said Zhang of Huashang. “They are also more complicated than straight bonds. Also due to the still small size of the market, liquidity may not be good.”




Related Story