As the chart above demonstrates, a convertible bond may go through different phases during its life depending on the underlying equity price and the conversion feature.
When the underlying equity price is below the conversion price, the bond will tend to act more like a debt security rather than an equity. As equity prices increase, the bond’s value will also increase due to the conversion feature.
The Sweet Spot
When the underlying equity price meets the conversion price, the investor enters a sweet spot where they are participating more in the equity upside while also collecting interest payments. As the equity price continues to rise, more equity sensitivity is experienced.
Combined, we like these characteristics in this elevated equity market environment.
Consider, for example, that though convertible bonds can participate in equity market gains, they have shown about 25% less volatility than the global equity market. This reduced volatility can translate into a more consistent return stream for investors—a smoother ride.