SUCCESS FACTORS
RMF INVESTMENT GROUP
Asset allocation skills because of the wide divergence between returns of sectors and
countries over certain periods
State-of-the-art models to keep up with the ever increasing sophistication of the other
market participants
Credit skills to assess the corporate bond-type credit risk
Relationships to investment banks for access to new issues and stock borrowing
(CB arbitrage)
Market timing skills to protect the capital in extended phases of equity market weakness
Risk management skills to avoid unwanted exposure to all types of risk including interest
rate and currency risk
Proprietary trading experience and mentality to take advantage of the relative value
characteristics of the instrument
SUMMARY
In recent years, the Convertibles market has grown at an accelerated pace. More and more
companies are willing to look at the advantages of financing through Convertibles, and they
find good demand from various investors such as Hedge Funds, Convertible Bond funds or
investment banks. We believe that this trend will continue and that this market will steadily
gain significance in the future
Convertible Bonds are instruments that are beneficial to both investors and issuers
Convertible Bonds are an asset class with risk-return characteristics that are superior to
those of pure bonds, pure equities, or a blend of bonds and equities
The successful management of Convertible Bond portfolios depends on various factors such
as asset allocation, security selection and credit skills, state-of-the-art models as well as good
relationships to investment banks for access to new issues
RMF commenced activities as an operative Hedge Fund Manager in 1992
with an exclusive mandate for one of the world’s most prestigious Market
Neutral Hedge Funds. Over the years, RMF has continued to focus on
servicing investors by providing comprehensive products and solutions
and is regarded as an innovator in the Alternative Asset Management
Industry.
In May 2002, RMF was acquired by the Man Group creating the largest
independent Alternative Investment Manager in the market, with approximately USD 20 billion under management (excluding Real Estate and
Private Equity). As of 30 June 2002 RMF had funds under management
of approximately USD 9.5 billion.
RMF is a process driven organisation, and one of the few organisations
in the financial services industry to have achieved the ISO 9001: 2000
Certification for Quality Management Systems.
CONTACT
For further information please contact:
Client Relations Team
RMF Investment Consultants
Huobstrasse 16
8808 Pfäffikon/SZ
Switzerland
Phone +41 (0) 55 415 87 10
Fax
+41 (0) 55 415 87 94
www.rmf.ch
info@rmf.ch
Disclaimer
The content of this documentation is for your information purposes only and constitutes neither a
request, nor an offer, nor a solicitation, nor a recommendation to buy, sell or make an investment in the
described investment instruments or to enter into or conclude other transactions of any kind. The
information provided herein is not intended to provide sufficient basis on which to make an investment
decision. Potential investors should note that alternative investments can involve significant risks and the
value of an investment may go down as well as up. Furthermore, we recommend you consult your bank,
or investment and/or tax adviser. Past performance is never an indication or guarantee of future
performance.
Information contained herein is provided from the RMF database or obtained from sources that RMF
considers to be reliable. However, although RMF has taken professional care in gathering and updating
this material and information, it does not assume any liability in the case of incorrectly reported or
incomplete information, accuracy or correctness. All projections, valuations and statistical analyses are
provided to assist the recipient in understanding the basics of alternative investments. Such projections,
valuations and analyses may be based on subjective assessments and assumptions and may use one
among several alternative methodologies (and other methodologies may produce different results).
Accordingly, such projections, valuations and statistical analyses should not be viewed as facts and
should not be relied upon as a prediction of future events.
The information in this documentation is not intended for persons and organizations subject to U.S.
federal, state or local law or to the law of any foreign jurisdiction prohibiting the use or attention of this
information whether on the basis of domicile, nationality or for other reasons. This document and all
information contained within is proprietary information of RMF and its affiliates and may not be
reproduced or otherwise disseminated in whole or in part without prior written consent from RMF.
A member of the Man Group
An Introduction to the Asset Class
Convertible Bonds
RMF Investment Group is the leading provider of Alternative Investment
Solutions, specialising in Hedge Funds, Leveraged Finance, Private Equity
and Convertible Bonds. Focused on the institutional market, RMF’s
target clients include pension funds, insurance companies, banks, large
corporations and distribution channels. RMF’s headquarters is in Switzerland, however the Company also has physical presence in the
major financial centres.
200/Q2_02
The following factors are critical for the success of a Convertible Bond investor:
CHARACTERISTICS (CONT.)
Investment Categories
Efficient Frontier
Convertibles are fascinating hybrid securities. On the one hand, they have the benefits of debt
instruments that pay fixed coupons and will be redeemed at maturity at a pre-specified price. On
the other hand, the embedded conversion option provides the investor with a participation in the
upside potential of the underlying equity.
Hybrid instrument (at-the-money)
Convertible Bonds where the underlying share price trades close to the conversion price are
considered balanced Convertibles because of their asymmetric payoff profile. They have a
medium sensitivity to changes in the underlying equity. These bonds are affected by the
share price performance and volatility movements as well as changes in interest rates and the
issuer’s credit profile. The majority of new issues are launched as balanced Convertibles.
The conversion right provides the bond holder with a better-of-two-choices option. At maturity,
the Convertible Bonds are worth the higher of (a) their redemption value (the price at which the
issuer had agreed to buy the bonds back) or (b) the market value of the underlying shares.
Equity alternative (deep-in-the-money)
Convertible Bonds where the underlying share price trades significantly above the conversion
price are highly sensitive to changes in the equity, whereas their sensitivity to changes in
interest rates and/or credit spreads is low. These bonds trade at an insignificant premium or
even a small discount to parity. Deep-in-the-money Convertibles will almost certainly be
converted into the underlying shares at maturity.
In other words, a Convertible Bond is a straight bond with an embedded equity call option. Due
to this call option, the Convertible will participate in any increase of the underlying equity, while
the fixed income portion provides capital protection, should the share price fall.
CHARACTERISTICS
Payoff profile
Yield Instrument
Hybrid Instrument
Equity Alternative
Price Behaviour of
Convertibles
ity
Par
rice
rtible P
Conve
Premium
Yield instrument (out-of-the-money)
Convertible Bonds where the underlying share price trades significantly below the conversion
price have low equity sensitivity and behave like fixed income securities. The main price
factors are the interest rate level and the issuer’s credit spread.
Bond Floor
Old
Price
130
New
Price
162.5
Capital Gain/
Loss
32.5
Cashflow
1.5
Total
Return
0.3
Convertible Bond
135
164.0
29.0
4.4
0.2
Share Price unchanged
Equity
130
130.0
0.0
1.5
0.0
Convertible Bond
135
135.0
0.0
4.4
0.0
Share Price - 25%
Equity
130
97.5
-32.5
1.5
-0.2
Convertible Bond
135
120.0
-15.0
4.4
-0.1
Share Price + 25%
Equity
Convertible price
Similarly to straight debt, a Convertible contains the risk of the issuer not being able to repay the
principal at maturity. This credit risk is expressed in the graph as the steep fall of the bond floor
as well as the bond price on the left-hand side.
The best risk-return profile is located in the red area where the Convertible’s potential upside is
the greatest while the downside risk is relatively low. RMF focuses on Convertible Bonds priced
in that area.
100% CB s,
0% B o nds
14%
12%
100% E quity ,
0% B onds
10%
100% B onds
8%
4%
9%
14%
Annualised Volatility
19%
Source: RMF Research
MARKET
Global Overview
The Convertible Bonds market has been growing over the last decade. The data indicate this trend
will continue in the future as both companies and investors become more aware of the benefits of
Convertible Bonds. The following map depicts the capitalisation of outstanding Convertible
Bonds divided by geographic region (as of December 2001).
162.5
135
130
120
Europe
USD 137 bn
Asia (ex Japan)
USD 29 bn
Japan
USD 91 bn
North America
USD 213 bn
Share Price
Source: RMF Research
In the long run, Convertible
Bonds can outperform pure
equity and/or pure bond portfolios. The studies further show
that CBs can replicate the upside
movements of the share prices
without the corresponding volatility.
Value Index
150
ML-G300 Global Convertibles
MSCI Global Equities
JPM Global Bonds
100
Jun 02
Jun 01
Dec 01
Dec 00
Jun 00
Dec 99
Jun 99
Jun 98
Dec 98
Jun 97
Dec 97
Jun 96
Dec 96
Dec 95
Jun 95
Dec 94
50
Source: Bloomberg
Correlation Matrix for
Convertibles and other
major Asset Classes
16%
97.5
200
The x-axis displays the underlying share price while the y-axis represents the price of the Convertible Bond. The dotted diagonal expresses the intrinsic value called parity. Parity represents
the value that the investor would receive upon conversion of the bond. Parity is a lower boundary for the price of the Convertible. The yellow line outlines the Convertible‘s fair value. If the
share price increases, the fair value of the Convertible Bond rises as well. As the share price
increases, the relationship between shares and bonds becomes more direct until the bond price
behaviour and risk profile resemble characteristics of the underlying equity. On the other hand,
if the share price falls, the bond‘s sensitivity to its underlying share price will decrease and the
bond will not decline to the same extent as the equity. The level which will prevent the Convertible from falling further down is shown in the above graph as the bond floor (grey) which is
also a lower boundary for the price of the Convertible.
18%
250
Global Performance
across Asset Classes
Source: RMF Research
The payoff of Convertible Bonds
surpasses the returns achieved by
either pure bonds or equities.
164
Source: RMF Research
Stock price
Market data indicate the advantage
of investing in CBs as compared to
fixed income instruments and/or
equities. The chart depicts the
efficient frontier analysis of investing
in bonds, equities and Convertible
Bonds.
Annualised Return
Convertible Bonds (CBs) are fixed income instruments that can be converted into a fixed number
of shares of the issuer at the option of the investor. Bonds that are convertible into shares other
than the issuer’s are called exchangeable bonds.
CHARACTERISTICS (CONT.)
Convertible Bond
DESCRIPTION
Convertible Large-Cap Small-Cap
Bonds
Stocks
Stocks
Convertible Bonds
Large-Capitalisation Stocks
Small-Capitalisation Stocks
Long-Term Treasury Bonds
Intermediate-Term Treasury Bonds
Treasury Bills
Long-Term Corporate Bonds
Intermediate-Term Corporate Bonds
Mortgage-Backed Securities
Real Estate
1.00
0.83
0.80
0.36
0.32
-0.01
0.51
0.52
0.42
-0.02
1.00
0.79
0.36
0.28
-0.09
0.51
0.48
0.35
-0.23
1.00
0.12
0.07
0.02
0.30
0.33
0.10
0.34
Long-Term
Treasury
Bonds
1.00
0.93
0.00
0.92
0.90
0.87
0.04
Intermediat
e-Term
Treasury
Bonds
1.00
0.25
0.91
0.94
0.91
0.09
Treasury
Bills
1.00
-0.01
0.19
0.14
0.25
IntermediateLong-Term
MortgageTerm
Corporate
Backed Real Estate
Corporate
Bonds
Securities
Bonds
1.00
0.97
0.95
0.07
1.00
0.93
0.16
1.00
-0.01
1.00
Source: Ibbotson Associates and Goldman Sachs
Correlations above are generally calculated using monthly total returns over the period 19732000. The exceptions are Mortgage Backed Securities, which use the period 1976-2000, and
Real Estate which uses quarterly returns for the period March 1978-September 2000.
The Convertible Bonds Market: USD 470 bn
Market Participants
Source: Merrill Lynch
Long-only investors including dedicated CB Funds
The strategy is to generate above average returns via capital gains and interest income while
enjoying downside protection and lower volatility. Studies show that Convertible Bond portfolios
have outperformed traditional portfolios (50% bonds and 50% equities) on a global basis from
1993 to 2000. During this period, they even outperformed pure equity portfolios (CBs returned
9.92% p.a., while equities returned 9.07% p.a.) (study by Jefferies).
Hedge Funds
CB arbitrage is a typical Hedge Fund strategy. The arbitrageur is long a Convertible and short the
underlying shares according to the CB‘s sensitivity to its underlying (delta), in order to extract the
Convertible‘s ‘cheapness’. If the share price falls, the CB becomes more bond-like and declines
less than the share price, so the trader buys back some shares. Similarly, if the share price rises,
the Convertible becomes more equity-like and the trader sells more shares. If it is possible to
repeat this operation on several occasions, the trader will always be buying low and selling high.
Equity investors
As equity investors need or want full upside exposure, their strategy would be to buy deep-in-themoney CBs. They could often generate an income advantage as the coupon yield is typically
higher than the dividend yield. Furthermore, they enjoy the benefit of the embedded call option
on the underlying equity as well as free downside protection, although that may be rather far
away. The investors could also take advantage of in-the-money CBs trading at a discount to
parity.
Fixed income investors
Fixed income investors tend to buy out-of-the-money CBs that are trading with yields close to
their corporate bond equivalents but contain the added bonus of upside participation of the
underlying share price.
CHARACTERISTICS (CONT.)
Investment Categories
Efficient Frontier
Convertibles are fascinating hybrid securities. On the one hand, they have the benefits of debt
instruments that pay fixed coupons and will be redeemed at maturity at a pre-specified price. On
the other hand, the embedded conversion option provides the investor with a participation in the
upside potential of the underlying equity.
Hybrid instrument (at-the-money)
Convertible Bonds where the underlying share price trades close to the conversion price are
considered balanced Convertibles because of their asymmetric payoff profile. They have a
medium sensitivity to changes in the underlying equity. These bonds are affected by the
share price performance and volatility movements as well as changes in interest rates and the
issuer’s credit profile. The majority of new issues are launched as balanced Convertibles.
The conversion right provides the bond holder with a better-of-two-choices option. At maturity,
the Convertible Bonds are worth the higher of (a) their redemption value (the price at which the
issuer had agreed to buy the bonds back) or (b) the market value of the underlying shares.
Equity alternative (deep-in-the-money)
Convertible Bonds where the underlying share price trades significantly above the conversion
price are highly sensitive to changes in the equity, whereas their sensitivity to changes in
interest rates and/or credit spreads is low. These bonds trade at an insignificant premium or
even a small discount to parity. Deep-in-the-money Convertibles will almost certainly be
converted into the underlying shares at maturity.
In other words, a Convertible Bond is a straight bond with an embedded equity call option. Due
to this call option, the Convertible will participate in any increase of the underlying equity, while
the fixed income portion provides capital protection, should the share price fall.
CHARACTERISTICS
Payoff profile
Yield Instrument
Hybrid Instrument
Equity Alternative
Price Behaviour of
Convertibles
ity
Par
rice
rtible P
Conve
Premium
Yield instrument (out-of-the-money)
Convertible Bonds where the underlying share price trades significantly below the conversion
price have low equity sensitivity and behave like fixed income securities. The main price
factors are the interest rate level and the issuer’s credit spread.
Bond Floor
Old
Price
130
New
Price
162.5
Capital Gain/
Loss
32.5
Cashflow
1.5
Total
Return
0.3
Convertible Bond
135
164.0
29.0
4.4
0.2
Share Price unchanged
Equity
130
130.0
0.0
1.5
0.0
Convertible Bond
135
135.0
0.0
4.4
0.0
Share Price - 25%
Equity
130
97.5
-32.5
1.5
-0.2
Convertible Bond
135
120.0
-15.0
4.4
-0.1
Share Price + 25%
Equity
Convertible price
Similarly to straight debt, a Convertible contains the risk of the issuer not being able to repay the
principal at maturity. This credit risk is expressed in the graph as the steep fall of the bond floor
as well as the bond price on the left-hand side.
The best risk-return profile is located in the red area where the Convertible’s potential upside is
the greatest while the downside risk is relatively low. RMF focuses on Convertible Bonds priced
in that area.
100% CB s,
0% B o nds
14%
12%
100% E quity ,
0% B onds
10%
100% B onds
8%
4%
9%
14%
Annualised Volatility
19%
Source: RMF Research
MARKET
Global Overview
The Convertible Bonds market has been growing over the last decade. The data indicate this trend
will continue in the future as both companies and investors become more aware of the benefits of
Convertible Bonds. The following map depicts the capitalisation of outstanding Convertible
Bonds divided by geographic region (as of December 2001).
162.5
135
130
120
Europe
USD 137 bn
Asia (ex Japan)
USD 29 bn
Japan
USD 91 bn
North America
USD 213 bn
Share Price
Source: RMF Research
In the long run, Convertible
Bonds can outperform pure
equity and/or pure bond portfolios. The studies further show
that CBs can replicate the upside
movements of the share prices
without the corresponding volatility.
Value Index
150
ML-G300 Global Convertibles
MSCI Global Equities
JPM Global Bonds
100
Jun 02
Jun 01
Dec 01
Dec 00
Jun 00
Dec 99
Jun 99
Jun 98
Dec 98
Jun 97
Dec 97
Jun 96
Dec 96
Dec 95
Jun 95
Dec 94
50
Source: Bloomberg
Correlation Matrix for
Convertibles and other
major Asset Classes
16%
97.5
200
The x-axis displays the underlying share price while the y-axis represents the price of the Convertible Bond. The dotted diagonal expresses the intrinsic value called parity. Parity represents
the value that the investor would receive upon conversion of the bond. Parity is a lower boundary for the price of the Convertible. The yellow line outlines the Convertible‘s fair value. If the
share price increases, the fair value of the Convertible Bond rises as well. As the share price
increases, the relationship between shares and bonds becomes more direct until the bond price
behaviour and risk profile resemble characteristics of the underlying equity. On the other hand,
if the share price falls, the bond‘s sensitivity to its underlying share price will decrease and the
bond will not decline to the same extent as the equity. The level which will prevent the Convertible from falling further down is shown in the above graph as the bond floor (grey) which is
also a lower boundary for the price of the Convertible.
18%
250
Global Performance
across Asset Classes
Source: RMF Research
The payoff of Convertible Bonds
surpasses the returns achieved by
either pure bonds or equities.
164
Source: RMF Research
Stock price
Market data indicate the advantage
of investing in CBs as compared to
fixed income instruments and/or
equities. The chart depicts the
efficient frontier analysis of investing
in bonds, equities and Convertible
Bonds.
Annualised Return
Convertible Bonds (CBs) are fixed income instruments that can be converted into a fixed number
of shares of the issuer at the option of the investor. Bonds that are convertible into shares other
than the issuer’s are called exchangeable bonds.
CHARACTERISTICS (CONT.)
Convertible Bond
DESCRIPTION
Convertible Large-Cap Small-Cap
Bonds
Stocks
Stocks
Convertible Bonds
Large-Capitalisation Stocks
Small-Capitalisation Stocks
Long-Term Treasury Bonds
Intermediate-Term Treasury Bonds
Treasury Bills
Long-Term Corporate Bonds
Intermediate-Term Corporate Bonds
Mortgage-Backed Securities
Real Estate
1.00
0.83
0.80
0.36
0.32
-0.01
0.51
0.52
0.42
-0.02
1.00
0.79
0.36
0.28
-0.09
0.51
0.48
0.35
-0.23
1.00
0.12
0.07
0.02
0.30
0.33
0.10
0.34
Long-Term
Treasury
Bonds
1.00
0.93
0.00
0.92
0.90
0.87
0.04
Intermediat
e-Term
Treasury
Bonds
1.00
0.25
0.91
0.94
0.91
0.09
Treasury
Bills
1.00
-0.01
0.19
0.14
0.25
IntermediateLong-Term
MortgageTerm
Corporate
Backed Real Estate
Corporate
Bonds
Securities
Bonds
1.00
0.97
0.95
0.07
1.00
0.93
0.16
1.00
-0.01
1.00
Source: Ibbotson Associates and Goldman Sachs
Correlations above are generally calculated using monthly total returns over the period 19732000. The exceptions are Mortgage Backed Securities, which use the period 1976-2000, and
Real Estate which uses quarterly returns for the period March 1978-September 2000.
The Convertible Bonds Market: USD 470 bn
Market Participants
Source: Merrill Lynch
Long-only investors including dedicated CB Funds
The strategy is to generate above average returns via capital gains and interest income while
enjoying downside protection and lower volatility. Studies show that Convertible Bond portfolios
have outperformed traditional portfolios (50% bonds and 50% equities) on a global basis from
1993 to 2000. During this period, they even outperformed pure equity portfolios (CBs returned
9.92% p.a., while equities returned 9.07% p.a.) (study by Jefferies).
Hedge Funds
CB arbitrage is a typical Hedge Fund strategy. The arbitrageur is long a Convertible and short the
underlying shares according to the CB‘s sensitivity to its underlying (delta), in order to extract the
Convertible‘s ‘cheapness’. If the share price falls, the CB becomes more bond-like and declines
less than the share price, so the trader buys back some shares. Similarly, if the share price rises,
the Convertible becomes more equity-like and the trader sells more shares. If it is possible to
repeat this operation on several occasions, the trader will always be buying low and selling high.
Equity investors
As equity investors need or want full upside exposure, their strategy would be to buy deep-in-themoney CBs. They could often generate an income advantage as the coupon yield is typically
higher than the dividend yield. Furthermore, they enjoy the benefit of the embedded call option
on the underlying equity as well as free downside protection, although that may be rather far
away. The investors could also take advantage of in-the-money CBs trading at a discount to
parity.
Fixed income investors
Fixed income investors tend to buy out-of-the-money CBs that are trading with yields close to
their corporate bond equivalents but contain the added bonus of upside participation of the
underlying share price.
CHARACTERISTICS (CONT.)
Investment Categories
Efficient Frontier
Convertibles are fascinating hybrid securities. On the one hand, they have the benefits of debt
instruments that pay fixed coupons and will be redeemed at maturity at a pre-specified price. On
the other hand, the embedded conversion option provides the investor with a participation in the
upside potential of the underlying equity.
Hybrid instrument (at-the-money)
Convertible Bonds where the underlying share price trades close to the conversion price are
considered balanced Convertibles because of their asymmetric payoff profile. They have a
medium sensitivity to changes in the underlying equity. These bonds are affected by the
share price performance and volatility movements as well as changes in interest rates and the
issuer’s credit profile. The majority of new issues are launched as balanced Convertibles.
The conversion right provides the bond holder with a better-of-two-choices option. At maturity,
the Convertible Bonds are worth the higher of (a) their redemption value (the price at which the
issuer had agreed to buy the bonds back) or (b) the market value of the underlying shares.
Equity alternative (deep-in-the-money)
Convertible Bonds where the underlying share price trades significantly above the conversion
price are highly sensitive to changes in the equity, whereas their sensitivity to changes in
interest rates and/or credit spreads is low. These bonds trade at an insignificant premium or
even a small discount to parity. Deep-in-the-money Convertibles will almost certainly be
converted into the underlying shares at maturity.
In other words, a Convertible Bond is a straight bond with an embedded equity call option. Due
to this call option, the Convertible will participate in any increase of the underlying equity, while
the fixed income portion provides capital protection, should the share price fall.
CHARACTERISTICS
Payoff profile
Yield Instrument
Hybrid Instrument
Equity Alternative
Price Behaviour of
Convertibles
ity
Par
rice
rtible P
Conve
Premium
Yield instrument (out-of-the-money)
Convertible Bonds where the underlying share price trades significantly below the conversion
price have low equity sensitivity and behave like fixed income securities. The main price
factors are the interest rate level and the issuer’s credit spread.
Bond Floor
Old
Price
130
New
Price
162.5
Capital Gain/
Loss
32.5
Cashflow
1.5
Total
Return
0.3
Convertible Bond
135
164.0
29.0
4.4
0.2
Share Price unchanged
Equity
130
130.0
0.0
1.5
0.0
Convertible Bond
135
135.0
0.0
4.4
0.0
Share Price - 25%
Equity
130
97.5
-32.5
1.5
-0.2
Convertible Bond
135
120.0
-15.0
4.4
-0.1
Share Price + 25%
Equity
Convertible price
Similarly to straight debt, a Convertible contains the risk of the issuer not being able to repay the
principal at maturity. This credit risk is expressed in the graph as the steep fall of the bond floor
as well as the bond price on the left-hand side.
The best risk-return profile is located in the red area where the Convertible’s potential upside is
the greatest while the downside risk is relatively low. RMF focuses on Convertible Bonds priced
in that area.
100% CB s,
0% B o nds
14%
12%
100% E quity ,
0% B onds
10%
100% B onds
8%
4%
9%
14%
Annualised Volatility
19%
Source: RMF Research
MARKET
Global Overview
The Convertible Bonds market has been growing over the last decade. The data indicate this trend
will continue in the future as both companies and investors become more aware of the benefits of
Convertible Bonds. The following map depicts the capitalisation of outstanding Convertible
Bonds divided by geographic region (as of December 2001).
162.5
135
130
120
Europe
USD 137 bn
Asia (ex Japan)
USD 29 bn
Japan
USD 91 bn
North America
USD 213 bn
Share Price
Source: RMF Research
In the long run, Convertible
Bonds can outperform pure
equity and/or pure bond portfolios. The studies further show
that CBs can replicate the upside
movements of the share prices
without the corresponding volatility.
Value Index
150
ML-G300 Global Convertibles
MSCI Global Equities
JPM Global Bonds
100
Jun 02
Jun 01
Dec 01
Dec 00
Jun 00
Dec 99
Jun 99
Jun 98
Dec 98
Jun 97
Dec 97
Jun 96
Dec 96
Dec 95
Jun 95
Dec 94
50
Source: Bloomberg
Correlation Matrix for
Convertibles and other
major Asset Classes
16%
97.5
200
The x-axis displays the underlying share price while the y-axis represents the price of the Convertible Bond. The dotted diagonal expresses the intrinsic value called parity. Parity represents
the value that the investor would receive upon conversion of the bond. Parity is a lower boundary for the price of the Convertible. The yellow line outlines the Convertible‘s fair value. If the
share price increases, the fair value of the Convertible Bond rises as well. As the share price
increases, the relationship between shares and bonds becomes more direct until the bond price
behaviour and risk profile resemble characteristics of the underlying equity. On the other hand,
if the share price falls, the bond‘s sensitivity to its underlying share price will decrease and the
bond will not decline to the same extent as the equity. The level which will prevent the Convertible from falling further down is shown in the above graph as the bond floor (grey) which is
also a lower boundary for the price of the Convertible.
18%
250
Global Performance
across Asset Classes
Source: RMF Research
The payoff of Convertible Bonds
surpasses the returns achieved by
either pure bonds or equities.
164
Source: RMF Research
Stock price
Market data indicate the advantage
of investing in CBs as compared to
fixed income instruments and/or
equities. The chart depicts the
efficient frontier analysis of investing
in bonds, equities and Convertible
Bonds.
Annualised Return
Convertible Bonds (CBs) are fixed income instruments that can be converted into a fixed number
of shares of the issuer at the option of the investor. Bonds that are convertible into shares other
than the issuer’s are called exchangeable bonds.
CHARACTERISTICS (CONT.)
Convertible Bond
DESCRIPTION
Convertible Large-Cap Small-Cap
Bonds
Stocks
Stocks
Convertible Bonds
Large-Capitalisation Stocks
Small-Capitalisation Stocks
Long-Term Treasury Bonds
Intermediate-Term Treasury Bonds
Treasury Bills
Long-Term Corporate Bonds
Intermediate-Term Corporate Bonds
Mortgage-Backed Securities
Real Estate
1.00
0.83
0.80
0.36
0.32
-0.01
0.51
0.52
0.42
-0.02
1.00
0.79
0.36
0.28
-0.09
0.51
0.48
0.35
-0.23
1.00
0.12
0.07
0.02
0.30
0.33
0.10
0.34
Long-Term
Treasury
Bonds
1.00
0.93
0.00
0.92
0.90
0.87
0.04
Intermediat
e-Term
Treasury
Bonds
1.00
0.25
0.91
0.94
0.91
0.09
Treasury
Bills
1.00
-0.01
0.19
0.14
0.25
IntermediateLong-Term
MortgageTerm
Corporate
Backed Real Estate
Corporate
Bonds
Securities
Bonds
1.00
0.97
0.95
0.07
1.00
0.93
0.16
1.00
-0.01
1.00
Source: Ibbotson Associates and Goldman Sachs
Correlations above are generally calculated using monthly total returns over the period 19732000. The exceptions are Mortgage Backed Securities, which use the period 1976-2000, and
Real Estate which uses quarterly returns for the period March 1978-September 2000.
The Convertible Bonds Market: USD 470 bn
Market Participants
Source: Merrill Lynch
Long-only investors including dedicated CB Funds
The strategy is to generate above average returns via capital gains and interest income while
enjoying downside protection and lower volatility. Studies show that Convertible Bond portfolios
have outperformed traditional portfolios (50% bonds and 50% equities) on a global basis from
1993 to 2000. During this period, they even outperformed pure equity portfolios (CBs returned
9.92% p.a., while equities returned 9.07% p.a.) (study by Jefferies).
Hedge Funds
CB arbitrage is a typical Hedge Fund strategy. The arbitrageur is long a Convertible and short the
underlying shares according to the CB‘s sensitivity to its underlying (delta), in order to extract the
Convertible‘s ‘cheapness’. If the share price falls, the CB becomes more bond-like and declines
less than the share price, so the trader buys back some shares. Similarly, if the share price rises,
the Convertible becomes more equity-like and the trader sells more shares. If it is possible to
repeat this operation on several occasions, the trader will always be buying low and selling high.
Equity investors
As equity investors need or want full upside exposure, their strategy would be to buy deep-in-themoney CBs. They could often generate an income advantage as the coupon yield is typically
higher than the dividend yield. Furthermore, they enjoy the benefit of the embedded call option
on the underlying equity as well as free downside protection, although that may be rather far
away. The investors could also take advantage of in-the-money CBs trading at a discount to
parity.
Fixed income investors
Fixed income investors tend to buy out-of-the-money CBs that are trading with yields close to
their corporate bond equivalents but contain the added bonus of upside participation of the
underlying share price.
SUCCESS FACTORS
RMF INVESTMENT GROUP
Asset allocation skills because of the wide divergence between returns of sectors and
countries over certain periods
State-of-the-art models to keep up with the ever increasing sophistication of the other
market participants
Credit skills to assess the corporate bond-type credit risk
Relationships to investment banks for access to new issues and stock borrowing
(CB arbitrage)
Market timing skills to protect the capital in extended phases of equity market weakness
Risk management skills to avoid unwanted exposure to all types of risk including interest
rate and currency risk
Proprietary trading experience and mentality to take advantage of the relative value
characteristics of the instrument
SUMMARY
In recent years, the Convertibles market has grown at an accelerated pace. More and more
companies are willing to look at the advantages of financing through Convertibles, and they
find good demand from various investors such as Hedge Funds, Convertible Bond funds or
investment banks. We believe that this trend will continue and that this market will steadily
gain significance in the future
Convertible Bonds are instruments that are beneficial to both investors and issuers
Convertible Bonds are an asset class with risk-return characteristics that are superior to
those of pure bonds, pure equities, or a blend of bonds and equities
The successful management of Convertible Bond portfolios depends on various factors such
as asset allocation, security selection and credit skills, state-of-the-art models as well as good
relationships to investment banks for access to new issues
RMF commenced activities as an operative Hedge Fund Manager in 1992
with an exclusive mandate for one of the world’s most prestigious Market
Neutral Hedge Funds. Over the years, RMF has continued to focus on
servicing investors by providing comprehensive products and solutions
and is regarded as an innovator in the Alternative Asset Management
Industry.
In May 2002, RMF was acquired by the Man Group creating the largest
independent Alternative Investment Manager in the market, with approximately USD 20 billion under management (excluding Real Estate and
Private Equity). As of 30 June 2002 RMF had funds under management
of approximately USD 9.5 billion.
RMF is a process driven organisation, and one of the few organisations
in the financial services industry to have achieved the ISO 9001: 2000
Certification for Quality Management Systems.
CONTACT
For further information please contact:
Client Relations Team
RMF Investment Consultants
Huobstrasse 16
8808 Pfäffikon/SZ
Switzerland
Phone +41 (0) 55 415 87 10
Fax
+41 (0) 55 415 87 94
www.rmf.ch
info@rmf.ch
Disclaimer
The content of this documentation is for your information purposes only and constitutes neither a
request, nor an offer, nor a solicitation, nor a recommendation to buy, sell or make an investment in the
described investment instruments or to enter into or conclude other transactions of any kind. The
information provided herein is not intended to provide sufficient basis on which to make an investment
decision. Potential investors should note that alternative investments can involve significant risks and the
value of an investment may go down as well as up. Furthermore, we recommend you consult your bank,
or investment and/or tax adviser. Past performance is never an indication or guarantee of future
performance.
Information contained herein is provided from the RMF database or obtained from sources that RMF
considers to be reliable. However, although RMF has taken professional care in gathering and updating
this material and information, it does not assume any liability in the case of incorrectly reported or
incomplete information, accuracy or correctness. All projections, valuations and statistical analyses are
provided to assist the recipient in understanding the basics of alternative investments. Such projections,
valuations and analyses may be based on subjective assessments and assumptions and may use one
among several alternative methodologies (and other methodologies may produce different results).
Accordingly, such projections, valuations and statistical analyses should not be viewed as facts and
should not be relied upon as a prediction of future events.
The information in this documentation is not intended for persons and organizations subject to U.S.
federal, state or local law or to the law of any foreign jurisdiction prohibiting the use or attention of this
information whether on the basis of domicile, nationality or for other reasons. This document and all
information contained within is proprietary information of RMF and its affiliates and may not be
reproduced or otherwise disseminated in whole or in part without prior written consent from RMF.
A member of the Man Group
An Introduction to the Asset Class
Convertible Bonds
RMF Investment Group is the leading provider of Alternative Investment
Solutions, specialising in Hedge Funds, Leveraged Finance, Private Equity
and Convertible Bonds. Focused on the institutional market, RMF’s
target clients include pension funds, insurance companies, banks, large
corporations and distribution channels. RMF’s headquarters is in Switzerland, however the Company also has physical presence in the
major financial centres.
200/Q2_02
The following factors are critical for the success of a Convertible Bond investor:
SUCCESS FACTORS
RMF INVESTMENT GROUP
Asset allocation skills because of the wide divergence between returns of sectors and
countries over certain periods
State-of-the-art models to keep up with the ever increasing sophistication of the other
market participants
Credit skills to assess the corporate bond-type credit risk
Relationships to investment banks for access to new issues and stock borrowing
(CB arbitrage)
Market timing skills to protect the capital in extended phases of equity market weakness
Risk management skills to avoid unwanted exposure to all types of risk including interest
rate and currency risk
Proprietary trading experience and mentality to take advantage of the relative value
characteristics of the instrument
SUMMARY
In recent years, the Convertibles market has grown at an accelerated pace. More and more
companies are willing to look at the advantages of financing through Convertibles, and they
find good demand from various investors such as Hedge Funds, Convertible Bond funds or
investment banks. We believe that this trend will continue and that this market will steadily
gain significance in the future
Convertible Bonds are instruments that are beneficial to both investors and issuers
Convertible Bonds are an asset class with risk-return characteristics that are superior to
those of pure bonds, pure equities, or a blend of bonds and equities
The successful management of Convertible Bond portfolios depends on various factors such
as asset allocation, security selection and credit skills, state-of-the-art models as well as good
relationships to investment banks for access to new issues
RMF commenced activities as an operative Hedge Fund Manager in 1992
with an exclusive mandate for one of the world’s most prestigious Market
Neutral Hedge Funds. Over the years, RMF has continued to focus on
servicing investors by providing comprehensive products and solutions
and is regarded as an innovator in the Alternative Asset Management
Industry.
In May 2002, RMF was acquired by the Man Group creating the largest
independent Alternative Investment Manager in the market, with approximately USD 20 billion under management (excluding Real Estate and
Private Equity). As of 30 June 2002 RMF had funds under management
of approximately USD 9.5 billion.
RMF is a process driven organisation, and one of the few organisations
in the financial services industry to have achieved the ISO 9001: 2000
Certification for Quality Management Systems.
CONTACT
For further information please contact:
Client Relations Team
RMF Investment Consultants
Huobstrasse 16
8808 Pfäffikon/SZ
Switzerland
Phone +41 (0) 55 415 87 10
Fax
+41 (0) 55 415 87 94
www.rmf.ch
info@rmf.ch
Disclaimer
The content of this documentation is for your information purposes only and constitutes neither a
request, nor an offer, nor a solicitation, nor a recommendation to buy, sell or make an investment in the
described investment instruments or to enter into or conclude other transactions of any kind. The
information provided herein is not intended to provide sufficient basis on which to make an investment
decision. Potential investors should note that alternative investments can involve significant risks and the
value of an investment may go down as well as up. Furthermore, we recommend you consult your bank,
or investment and/or tax adviser. Past performance is never an indication or guarantee of future
performance.
Information contained herein is provided from the RMF database or obtained from sources that RMF
considers to be reliable. However, although RMF has taken professional care in gathering and updating
this material and information, it does not assume any liability in the case of incorrectly reported or
incomplete information, accuracy or correctness. All projections, valuations and statistical analyses are
provided to assist the recipient in understanding the basics of alternative investments. Such projections,
valuations and analyses may be based on subjective assessments and assumptions and may use one
among several alternative methodologies (and other methodologies may produce different results).
Accordingly, such projections, valuations and statistical analyses should not be viewed as facts and
should not be relied upon as a prediction of future events.
The information in this documentation is not intended for persons and organizations subject to U.S.
federal, state or local law or to the law of any foreign jurisdiction prohibiting the use or attention of this
information whether on the basis of domicile, nationality or for other reasons. This document and all
information contained within is proprietary information of RMF and its affiliates and may not be
reproduced or otherwise disseminated in whole or in part without prior written consent from RMF.
A member of the Man Group
An Introduction to the Asset Class
Convertible Bonds
RMF Investment Group is the leading provider of Alternative Investment
Solutions, specialising in Hedge Funds, Leveraged Finance, Private Equity
and Convertible Bonds. Focused on the institutional market, RMF’s
target clients include pension funds, insurance companies, banks, large
corporations and distribution channels. RMF’s headquarters is in Switzerland, however the Company also has physical presence in the
major financial centres.
200/Q2_02
The following factors are critical for the success of a Convertible Bond investor: