Total returns from underappreciated asset class
JPMorgan Global Convertibles Income Fund Limited (Jpmorgan Gl (LONDON:JGCI)), launched in mid-2013, seeks to provide investors with income (current yield of 4.4%) and long-term capital growth potential by investing globally in convertible bonds, which combine a degree of equity upside with the regular income and capital preservation characteristics of bonds. It is the only closed-end fund of its kind in the UK, and has so far delivered on its income objective, paying a 4.5p dividend in its first year. Unfavourable conditions in the higher-yield segment of the convertibles market have made total returns harder to achieve in recent months, but the managers see catalysts for recovery and performance year to date in 2015 has been positive.
Investment strategy: Striking the right balance
Because of its primary income focus, JGCI invests in convertible bonds in the bond-like to balanced segments of the market (see Exhibit 2, page 3). These offer greater yield but less capital appreciation potential than more equity-like convertibles. The management team at J.P. Morgan Asset Management uses bottom-up analysis of issuing companies and individual securities, combined with a more top-down assessment of market fundamentals, to build a portfolio with the appropriate balance of yield, capital appreciation and downside protection. The managers aim to employ the investment process consistently over time, to ensure repeatability of returns.
Rationale for convertible investment
Convertibles can offer the yield and capital protection characteristics of a corporate bond – they can be redeemed at par, providing a ‘floor’ value (as long as there is no default) and pay regular coupons. However, because they can be converted into equity at a date in the future, they also give investors the chance to participate in a rising share price. While they may underperform straight bonds in times of significant risk aversion, and will tend to lag a strongly rising equity market, over significant periods they have delivered superior risk-adjusted returns versus both bonds and equities (see page 6 of our June 2013 initiation note on JGCI).
Outlook: Upside potential with downside protection
Stock markets have continued to perform strongly in an environment of continued monetary accommodation, pushing out the possibility of interest rate rises further into the future. Convertibles will tend to lag a rising equity market, but the equity-like and balanced segments of the sector will still benefit from rising equity valuations, while the bond-like space is benefiting from downward pressure on straight bond yields as a result of QE in Europe.
Valuation: Regular issuance to manage premium
JGCI has been in high demand since launch, probably owing to a combination of its attractive yield and the lack of direct competitors. At 28 April its shares were trading at a 1.0% discount to NAV compared with a 2.9% average premium since inception in June 2013. Regular share issuance helps to manage the premium, and 59.8m shares have been issued in the past 12 months (an increase of 37.7%).
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