The Financial Trend to Watch in 2024: Convertibles Take the Spotlight

Highlights

• Convertible notes expected to be a major financial trend in 2024.
• Refinancing needs and rising interest rates to drive the resurgence.
• Hybrid bonds offer steady income with the potential to convert to shares.
• Post-pandemic boom in 2020 and 2021 followed by a downturn in 2022.
• Over $200 billion of convertible securities set to mature by 2025.
• Despite challenges, fresh convertible models are being engineered.
• U.S. interest rates at a two-decade high, making convertible bonds attractive.
• Issuance surged by 34% by mid-November 2023 compared to the previous year.
• Established companies like Duke Energy entering the convertible bond market.
• Fund managers find appeal in buying bonds and short-selling underlying equity.
• Rising interest rates allow managers to invest short proceeds in higher-yielding Treasury bills.
• Convertibles set to be a hot financial model in 2024, combining stability and profit potential.

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In the ever-evolving landscape of finance, a promising trend is set to take centre stage in 2024 – the resurgence of convertible notes. Crafted by Jeffrey Goldfarb, this financial outlook suggests that refinancing needs and rising interest rates will breathe new life into these hybrid bonds, once the tool that propelled Citadel founder Ken Griffin from Harvard student to billionaire hedge fund manager.

The convertible notes, offering a unique blend of steady income and the potential to convert into shares at predetermined prices, faced a downturn after a staggering $370 billion boom during the pandemic years of 2020 and 2021. However, the allure of the equity component increased as stock markets soared, leading to the issuance of dozens of convertible notes with zero interest, exemplified by Peloton Interactive’s $1 billion offering that required a 60% stock price increase to convert.

Reality hit hard in 2022 as the S&P 500 Index dropped by approximately 20%, leaving over $200 billion of these securities set to mature by 2025, with associated stocks often languishing below their conversion prices. Peloton, for instance, saw a drastic 90% drop since borrowing the funds.

Amidst the market challenges, innovative models are emerging. With U.S. interest rates at a two-decade high, the appeal of convertible bonds with lower coupons and delayed equity dilution is on the rise. By mid-November 2023, issuance had surged by 34% compared to the previous year, contrasting sharply with declines in leveraged loans and modest increases in investment-grade debt.

Established companies like Duke Energy, leveraging its investment-grade rating, are entering the convertible bond arena. In 2023, Duke Energy issued its first convertible bond, utilizing the funds to retire short-term debt.

Fund managers are also finding renewed interest in Griffin’s signature trade, offering a straightforward strategy: purchase the bonds and short-sell the underlying equity. This approach provides protection for the bond’s downside if the stock declines while profiting from the short position. Rising interest rates add an intriguing twist, allowing managers to invest short proceeds in higher-yielding Treasury bills, enhancing overall returns.

While introducing leverage and derivatives adds risk, these extra features are expected to make convertibles the financial model to watch in 2024. As the financial landscape continues to evolve, convertible notes are poised for a comeback, offering a blend of stability and profit potential in an ever-changing market.