![Emerging market tech firms play a key role in the AI story](/content/dam/invesco/us/en/images/insights/ARTCL-HRO-AI-in-emerging-markets.jpg)
Equities
Emerging market tech firms play a key role in the AI story
As the artificial intelligence story evolves, emerging market tech companies seek to expand their competitive edge in enabling generative AI solutions.
Investors have had a difficult time finding any safe havens during this year’s sell-off in the equity and bond markets, and convertible securities have been no exception. The universe for convertible securities tends to be concentrated in the technology, health care, and consumer industries, and as a result the asset class has declined along with those equity sectors. Nevertheless, we believe convertibles may still present opportunities for investors in the current environment for several reasons.
Historically, convertible securities have performed well during periods of rising interest rates. Due to their generally short maturities of five years or less, as well as the inclusion of puts and calls, convertible securities tend to have shorter durations than non-convertible bonds.
The convertible universe, as measured by the ICE BofA US Convertible Index, currently has a duration of 2.1 years.1 For comparison, high yield has an average duration of 4.3 years (Bloomberg U.S. Corporate High Yield Total Return Index) and investment grade debt has an average duration of 6.5 years (Bloomberg U.S. Aggregate Total Return Value Unhedged Bond Index).1 While convertibles are affected by interest-rate fluctuations just like other fixed income assets, they are also impacted by the price movements of their underlying stock – and this has tended to help in periods of rising interest rates. This is because equities historically tend to outperform traditional fixed income when rates rise.
As shown in the chart below, since December 1989, there have been 13 periods in which U.S. 10-year Treasury yields have risen more than 118 basis points (bps). During these periods, convertibles outperformed investment grade corporate and government bonds in all periods, and they even outperformed the S&P 500 Index in four of those periods. In addition, convertible securities outperformed high yield and senior loans in eight out of the past ten periods.
|
12/21/89-5/2/90 |
10/16/93-11/7/94 |
1/18/96- 7/05/96 |
10/5/98- 1/20/00 |
11/7/01- |
6/13/03- |
6/2/05- |
12/18/08-6/10/09 |
10/6/10-2/8/11 |
7/25/12- |
7/8/16- |
9/7/17- |
3/9/20- |
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
10-year US Treasury yield increase (bps) |
132 |
286 |
153 |
263 |
122 |
176 |
136 |
190 |
134 |
161 |
124 |
118 |
120 |
ICE BofAML US Convertible Index (%) |
-2.13 |
-2.33 |
8.75 |
48.75 |
2.00 |
12.10 |
8.48 |
24.92 |
11.76 |
24.08 |
6.23 |
10.14 |
55.32 |
S&P 500 Index (%) |
-1.85 |
1.55 |
9.24 |
35.98 |
3.52 |
15.76 |
5.52 |
7.56 |
15.30 |
28.13 |
7.20 |
17.97 |
44.18 |
Bloomberg US Government/ Credit Index (%) |
-2.64 |
-6.18 |
-3.81 |
-3.19 |
-3.56 |
-3.95 |
-1.94 |
-1.89 |
-2.40 |
-1.46 |
-4.98 |
-2.96 |
-2.88 |
Bloomberg US Corporate High Yield (%) |
N/A |
N/A |
N/A |
2.84 |
4.73 |
9.47 |
4.41 |
41.87 |
5.83 |
10.09 |
5.36 |
3.04 |
12.77 |
S&P LSTA Leveraged Loan Index (%) |
N/A |
N/A |
N/A |
4.87 |
3.52 |
7.12 |
6.26 |
34.00 |
5.29 |
6.49 |
4.66 |
5.21 |
9.30 |
Source: Invesco, RIMES Technologies Corp.
Past performance is not an indication of future performance, provides no guarantee for the future and is not constant over time. Please keep in mind that high, double-digit and/or triple-digit returns are highly unusual and cannot be sustained. An investment cannot be made into an index. Does not reflect or imply the performance of any Invesco Fund.
Convertibles (as represented by the ICE BofA US Convertible Index) have declined roughly -20% in 2022, far less than the -36% decline in the stocks that underlie those securities.2 Convertible securities have also outperformed the NASDAQ composite and Russell 2000 indices on a year-to-date basis (-29.2% and -23.4%, respectively).3 Convertibles have essentially delivered on one of their benefits of falling less than their issuers’ common stock, due to their fixed income component.
As stock prices and convertible securities prices have declined, the yields on those convertibles have increased. The average yield (yield to maturity or put) on a U.S. convertible bond has moved from 2.6%4 at the start of the year to most recently 5.2%5, according to Barclays, with approximately 40% of the convertible market now more considered “credit sensitive,” almost double the percentage from the start of the year.6 Credit sensitive convertibles exhibit less equity sensitivity and more bond-like characteristics such as higher yields, higher conversion premium, and less downside risk relative to the common stock.
The increase in the number of credit sensitive convertibles has attracted interest from non-traditional buyers in the asset class, as investors normally focused on non-convertible debt are finding attractive yields combined with cheap, although out of the money, imbedded call options in convertibles. Additionally, many of these non-traditional investors are attracted by the opportunity to invest in companies not typically found in the traditional fixed income space, as nearly three-quarters of companies with outstanding convertibles don’t have any non-convertible debt outstanding, according to Barclay’s data.7 We believe this could be supportive of the asset class going forward.
Convertible prices have cheapened on a theoretical basis, meaning that prices have declined relative to the credit strength of the bond’s issuer and the volatility in the underlying stock. In fact, U.S. convertibles are currently undervalued, according to Bank of America (see the graph below),8 near the cheapest they have been since the depths of the pandemic over two years ago.
Source: BofA Global Research as of June 30, 2022. Past performance does not guarantee future results. Data is based on the ICE BofA US Convertible Index. An investment cannot be made into an index.
To summarize, while stocks and bonds haven’t exactly shined during this current pullback, the Invesco Convertible Securities Team sees reasons for optimism in the convertible space. These securities have historically performed well during periods of rising rates, and as of late they have performed as designed, falling far less than their underlying stocks.
Convertibles may also be supported by interest from new investors, and the market is now at its lowest valuation since the start of the pandemic, more than two years ago. And as always, the asset class can provide diversification, offering lower interest rate sensitivity versus traditional fixed income and potentially lower volatility versus equites.
The Invesco Convertible Securities team continues to focus on what we believe is the best opportunity in this market –convertibles that may offer both upside participation should their underlying stocks rise and may offer downside support via the securities’ fixed income attributes. Additionally, given the increase in the number of convertible issues now offering attractive yields, we are selectively adding credit sensitive bonds to the portfolio, which we believe may provide worthwhile returns and mitigate on the downside at lower prices.
Source: ICE data indices, Bloomberg May 23, 2022. Duration refers to the price sensitivity of a bond, or a portfolio of bonds, to a change in interest rates. It is measured in years. The higher the duration, the greater the responsiveness of the bond price – or the value of a bond portfolio – to a change in interest rates.
Source: BofA Global Research, ICE Data Indices LLC, as of June 30, 2022.
Source: Morningstar Direct, as of 6/30/22.
Source: Barclays, as of 1/13/22.
Source: Barclays, as of 6/30/22.
Source: Barclays, as of 6/30/22.
Source: Barclays, as of 5/17/22.
Source: BofA Global Research, ICE Data Indices LLC, as of June 30, 2022.
Emerging market tech firms play a key role in the AI story
As the artificial intelligence story evolves, emerging market tech companies seek to expand their competitive edge in enabling generative AI solutions.
Are small- and mid-sized companies primed to outperform?
Lower interest rates may set the stage for small- and mid-cap outperformance. Our investment experts share their strategies and what they’re excited about in this market segment.
Four reasons to consider value investing now
A lower recession risk should benefit value investing in the near term, while moderate interest rates and inflation would be a longer-term tailwind, in our view.
Important information
NA2272714
Header image: Hiraman/Getty Images
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
All investing involves risk, including the risk of loss. Past performance is not a guarantee of future results.
Diversification does not guarantee a profit or eliminate the risk of loss.
The investment techniques and risk analysis used by the Fund’s portfolio managers may not produce the desired results.
Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality.
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
A decision as to whether, when and how to use options involves the exercise of skill and judgment and even a well conceived option transaction may be unsuccessful because of market behavior or unexpected events. The prices of options can be highly volatile and the use of options can lower total returns.
Preferred securities may include provisions that permit the issuer to defer or omit distributions for a certain period of time, and reporting the distribution for tax purposes may be required, even though the income may not have been received. Further, preferred securities may lose substantial value due to the omission or deferment of dividend payments.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.
Convertible securities may be affected by market interest rates, issuer default, the value of the underlying stock or the right of the issuer to buy back the convertible securities. Investments in convertible securities are subject to the risks associated with both fixed-income securities, including credit risk and interest rate risk, and common stocks. Convertible securities may have lower yields because they offer the opportunity to be converted into stock and if the stock is underperforming and the bond does not convert then the bond may have a lower return than a non-convertible bond.
A convertible security is an investment that can be changed into another form, such as convertible bonds that can be changed into common stock.
A put option gives an investor the right to sell a security at a specified price within a certain time frame.
A call option gives an investor the right to buy a security at a specified price within a certain time frame.
A basis point is one hundredth of a percentage point.
"Out of the money" (OTM) is an expression used to describe an option contract that only contains extrinsic value.
The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded.
The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
The ICE BofA US Convertible Index is an unmanaged index that measures performance of US dollar-denominated convertible securities not currently in bankruptcy with a total market value greater than $50 million at issuance.
The Nasdaq Composite is a market capitalization-weighted index of more than 3,700 stocks listed on the Nasdaq stock exchange. As a broad index heavily weighted toward the important technology sector, the Nasdaq Composite Index has become a staple of financial markets reports.
The Bloomberg US Government/Credit Bond Index is a broad-based flagship benchmark that measures the non-securitized component of the US Aggregate Index. The index includes Treasuries and agencies that represent the government portion of the index, and it includes publicly issued US corporate and foreign debentures and secured notes that meet specified maturity, liquidity and quality requirements to represent the credit interests.
The S&P/LSTA Leveraged Loan Index is designed to reflect the performance of the largest facilities in the leveraged loan market.
The Russell 2000 Index refers to a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index. The Russell 2000 is managed by London's FTSE Russell Group. The Russell 2000 Index is a trade-mark/service mark of the Frank Russell Co. Russell® is a trademark of the Frank Russell Co. An investment cannot be made directly in an index.The Russell 2000 Index is a trade-mark/service mark of the Frank Russell Co.
The opinions referenced above are those of the author as of July 7, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their financial professionals for a prospectus/summary prospectus or visit invesco.com.
This link takes you to a site not affiliated with Invesco. The site is for informational purposes only. Invesco does not guarantee nor take any responsibility for any of the content.