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Are convertible bonds really attractive?. Alain Eckmann, CFA. International Investment Italian Forum November 8th, 2007. Table of Contents. SECTION 1 Convertibles an attractive investment!? 2 SECTION 2 The global convertible bond market 5

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are convertible bonds really attractive

Are convertible bonds really attractive?

Alain Eckmann, CFA

International Investment Italian Forum

November 8th, 2007

table of contents
Table of Contents

SECTION 1 Convertibles an attractive investment!?2

SECTION 2 The global convertible bond market5

SECTION 3 Will convertible bonds stay attractive?9

SECTION 4 Conclusion18

section 1

SECTION 1

Convertibles an attractive investment!?

attractive risk return attributes
Attractive risk/return attributes

Global convertibles hedged in EUR 1994 – 2007

* Internal calculations

Past performance is no guarantee of future trends.

Source: Datastream, Bloomberg, UBS.

Data as of August 31, 2007.

but is the future always like the past
But is the future always like the past?

Unfortunately asset allocation is more complicated than that

Average return from March 2000 -8% p.a.

Average return to March 2000 35% p.a.

Nasdaq Composite Index 1994-2007

section 2

SECTION 2

The global convertible bond market

global convertible bond issuance 1995 2007
Global Convertible Bond Issuance 1995-2007

Growing global issuance, but with mixed regional themes

Source: UBS AG, MACE Advisors.

Data as of August 31, 2007.

global convertible bond universe size
Global convertible bond universe size

Region

USD billions

Number of convertible bonds

US

312

1 050

Europe

153

428

Japan

62

351

Asia ex-Japan

62

555

Other

24

183

Total

613

2 567

Source: UBS AG, MACE Advisors.

Datas as of December 31, 2006.

global convertible bond sectors
Global convertible bond sectors

Source: UBS AG, MACE Advisors, Datastream.

Datas as of December 31, 2006.

section 3

SECTION 3

Will convertible bonds stay attractive?

convertible bonds give exposure to
Convertible bonds give exposure to…
  • Equity markets
  • Credit markets
  • Interest rates changes
  • Volatility changes

Exposure to all these factors can also be taken on a stand alone basis

But

The convertible bond asset class offers more than the sum of the above and has therefore a very attractive risk/reward profile

main performance drivers of convertible bonds
Main performance drivers of convertible bonds

More than the sum of classical performance drivers

Convertible bond

Bond content

Equity content

Prospectus

Duration exposure

Credit exposure

FX exposure

Volatility exposure

Equity exposure

Issuance behaviour & valuation

Correlation

equity markets versus convertible bond implied volatility
Equity markets versus convertible bond implied volatility*

50

350

Average implied volatility

45

40

300

Wealth Index

35

30

250

25

20

200

15

10

150

5

0

100

19/05/2002

19/08/2002

19/11/2002

19/02/2003

19/05/2003

19/08/2003

19/11/2003

19/02/2004

19/05/2004

19/08/2004

19/11/2004

19/02/2005

19/05/2005

19/11/2006

19/08/2006

19/05/2000

19/08/2000

19/11/2000

19/02/2001

19/05/2001

19/08/2001

19/11/2001

19/02/2002

19/08/2005

19/11/2005

19/02/2006

19/05/2006

UBS Convertible Bond Index - Eurozone (EUR) Average Implied Volatility (LHS)

MSCI EMU (RHS)

Source: UBS AG, MACE Advisors.

Datas as of December 31, 2006.

* We refer here to the European market, as the longest-running time series of average implied volatilities happens to be available for this particular market (as proxied by the UBS Convertible Bond Index).

why convertible bonds cannot be replicated
Why convertible bonds cannot be replicated
  • Bond as exchange property
  • Better investor protection in comparison to traditional options
  • Optionality for companies where there is no liquid option market
  • Recurrent value added due to suboptimal call exercises by issuers
cheap issuance
Cheap issuance

Average cheapness of US convertible bond new issues

4,50

4,1

4,00

3,50

2,92

3,00

2,51

2,50

2,3

Percentage of cheapness

2,06

2,00

1,69

1,50

1,26

1,00

0,50

0,00

2000

2001

2002

2003

2004

2005

2006

Source: Lehman Brothers

Datas as of December 31, 2006.

cheap issuance16
Cheap issuance

35%

32,8%

Equities

Convertible Bonds

30%

26,6%

26,2%

25%

21,6%

19,8%

20%

18,5%

18,1%

17,8%

Issuance as a percentage of Market Capitalzation

17,4%

15%

10,9%

10%

5%

2,4%

2,0%

1,7%

1,6%

1,6%

1,5%

1,4%

1,4%

1,1%

0,8%

0%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

New issuance as a percentage of market capitalization

Source: SDC, Datastream, Lehman Brothers, MACE Advisors, UBS AG.

Datas as of December 31, 2004.

benefits of high borrow cost
Benefits of high borrow cost

18,00

17,80

17,60

17,35

17,40

17,16

17,20

16,99

Theoretical Value in USD

17,00

16,83

16,80

16,69

16,60

16,40

16,20

16,00

1,0%

2,0%

3,0%

4,0%

5,0%

Annual Stock Borrow

Theoretical value of General Motors $6.25 2033 for various levels of lending fees

Source: Bloomberg.

Datas as of December 31, 2006.

section 4

SECTION 4

Conclusion

conclusion
Conclusion

Convertible bonds are an attractive asset class

  • Recurrent value added due to under-priced new issues
  • Recurrent value added due to suboptimal call exercises by issuers
  • Very good protection of optionality against corporate actions (takeover, dividends)
  • Optionality often priced with high stock borrow which favours outright investors (as else it wouldn’t work for hedge funds)
  • Exposure to correlation (the bond value is the exchange property)
  • Can not be replicated with other asset classes
  • Attractive risk/reward
  • Convertible arbitrage a very successful hedge fund strategy
attractive convertible bonds
Attractive convertible bonds…

might be something for you?

alain eckmann cfa
Alain Eckmann, CFA

Senior Portfolio Manager

Executive Director

  • Alain Eckmann is a Senior Portfolio Manager within the Asymmetric Portfolio Solutions team. He is responsible worldwide for the convertible bond capability within UBS Global AM, which he helped to build up.
  • Alain joined the Asymmetric Portfolio Solutions team in 1997. His responsibilities included managing and enhancing the capabilities offered (capital preservations, currency overlay, Dynamic Alpha), and developing tailored client solutions.
  • During his studies, Alain worked for a private bank in Geneva, dealing with quantitative questions in asset management. After graduation, he built up a risk-management/risk-controlling department at Julius Baer in Zurich, developing mathematical methods to quantify market risks (VaR, etc).
  • Alain is co-author of the publications Exotic Options: A guide through the jungle of financial innovations, and The benefits of convertible bonds and is a regular speaker at international conferences. In addition, he is a member of the Swiss CFA Society and of the CFA Institute.

Years of investment industry experience: 13

Education: University of Geneva (Switzerland), dipl.

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November 2007

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