Book Review: Convertible Securities | Search alpha

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Convertible Effects

Convertible Securities: A Complete Guide to Investment and Corporate Financing Strategies. 2022. Tracy V. Maitland, F. Barry Nelson, CFA and Daniel G. Partlow. McGraw Hill.

Professionals considering investing in, hedging or issuing investment grade or speculative grade convertible bonds or public or private market preferences in North America, Europe or Asia will find just about everything they need to know in Convertible Securities: A Complete Guide to Investment and Corporate Financing Strategies. Evidence on, among other things, the use of convertibles to diversify a portfolio or to optimize a capital structure is meticulously backed up with empirical data and reinforced with case studies. If readers want more detail on certain topics than even the 560 pages of the book can contain, they can follow helpful references to material on the Advent Capital Management website, where Tracy V. Maitland, F. Barry Nelson, CFAand Daniel G. Partlow apply their expertise in convertible bond management. In addition, the book describes the evolution of the asset class from its 19th-century origins through the investment implications of the Tax Cuts and Jobs Act of 2017 and recent changes in accounting standards for convertible issuers.

The authors address a wide audience. Lay investors can apply basic financial theory, presented as background, to activities well beyond the confines of the convertible market. At the same time, the book presents quantitatively sophisticated valuation methods and trading strategies, using art terms that will be new even to many experienced practitioners – for example, ‘ASCOTs’, ‘zomma’, ‘nuking’ and ‘happy meal’. “

It is the duty of the reader to pay strict attention throughout to the carefully thought-out wording of the authors. Tracy Maitland, the founder of Advent, recalls his introduction to financial markets in the 1980s, stating in his foreword “the long-term return of convertible bonds was equal to the return of common stocks, but with significantly less risk.” . To bring the story up to date in the main text, the authors state that “historically convertibles have made a comeback”. about as much as common stock in the long run.” To avoid exaggerating things, they write on another point: typical offer less volatility than stocks.” Equally cautious is this comment: “The record convertible indices actually matching the returns of stock indices over the past decades can partially reflect the superior growth of convertible bond issuers compared to the growth of companies in the equity indices” (added in italics in the preceding sentences). One message that stands out is the asymmetric behavior of convertible bonds, with a large proportion of the upside potential of the associated stocks is captured while it is captured the downside through the bond side of their nature.

Of the many helpful observations that touch on the main topic, two call for a little annotation. First, the authors state that “because risk increases over time, longer-term securities tend to have wider credit spreads than shorter-term securities.” Data from ICE Indices, LLC confirmed that, except from December 2007 to March 2009, the option-adjusted spread (OAS) on 10- to 15-year US investment-grade corporate bonds consistently beat the OAS over 3- to 5-year troubles. However, for high yield bonds, the 3 to 5 year OAS is usually higher than the 10 to 15 year OAS.

Second, the authors state that “entities that have the ability to print money are considered completely risk-free because they can repay their debt under any circumstances with currency that they can create alone.” In fact, control over a currency is a necessary, but not a sufficient condition for having zero risk of default. History records a number of sovereign defaults on debt denominated in its own currency, such as Russia’s 1998 default on its ruble debt. In this regard, it’s also worth bearing in mind that the US Treasury has a Standard & Poor’s rating of only AA+, not the agency’s highest rating (AAA).

“Busted” (out-of-the-money) convertibles represent another time-honored topic in fixed income circles. Some bond sellers have promoted the belief that these issues are invariably neglected once they cease to be of interest to convertible investors, thus becoming bargains with yields in excess of the yields of comparable ordinary (non-convertible) bonds. Maitland, Nelson and Partlow judiciously state that convertibles are priced at discounts as low as “have the potential to significantly outperform non-convertible bonds” (italics added).

As with most books, a few small items in Convertible Effects bear clean up in a future edition. The book references the ICE BofA US High Yield Corporate Index under its former name, the High Yield Master II Index. Other editorials include mentions of the BlackRock ‘Alladin’ fund, the ‘Capital Assets Pricing Model’ and the ‘Discounted Dividend Model’.

These stylistic peccadillos do not detract from the many delights that the readers of . to wait Convertible Effects. You don’t expect to discover in a heavy tome on finance the Latin antecedent of the saying coined by Shakespeare, ‘It’s Greek to me’. Similarly coincidental is a Talmudic commentary on the symbolism of the Hebrew analogs of the Greek letters gamma and delta. Most importantly, though, are the original research contributions that enrich coverage of every aspect of the convertible ecosystem. Jamie Dinan, CEO of York Capital Management, is right: Convertible Effects a “remarkably comprehensive book.”

Full disclosure: The reviewer is mentioned in this book’s acknowledgments and in an endnote.

Disclaimer: Please note that the contents of this site should not be construed as investment advice, nor do the views expressed necessarily reflect the views of CFA Institute.

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Editor’s Note: The summary bullet points for this article were chosen by the editors of Seeking Alpha.

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