JPMorgan Global Convertible benefits from discount tightening – JPMorgan Global Convertible Income had a better year over the course of the 12 months ended 30 June 2017. The total return on net assets was +9.2% and shareholders enjoyed an even stronger performance, with a total gain of 19.1% (dividends reinvested). The fund did underperform its benchmark, however. The Bloomberg Barclays Credit Sensitive Convertibles Index (hedged into sterling) returned 10.8%. The chairman’s statement says that the underperformance against the reference index is largely attributable to the presence of a few large bank issued convertibles in the index in which the portfolio had significant underweight positions.
The share price benefitted from a substantial narrowing of the discount following the introduction of a 2% discount policy in May this year.
Three quarterly dividends totalling 3.375p per share have been declared and paid during the year. On 1st September 2017, the Board declared a fourth quarterly dividend of 1.125p per share to be paid on 26th October 2017, bringing the total dividend for the year to 4.5p.
The managers say that “the portfolio benefitted from the combination of a considerable tightening in credit spreads and supportive equity market performance, vindicating our belief that convertible bonds could perform well in a reflationary environment. This is reflected in the fact that while over the year the interest rate sensitivity of our holdings detracted from performance, as we would expect in a rising rate environment, this was more than offset by the positive contributions from credit and equity factors.”
They go on to say that “Throughout much of 2016, the portfolio had been positioned solidly within the bond-like part of the convertible universe. Bond-like convertibles are those where the majority of the return is expected to come in the form of interest income and exposure to credit and interest rate factors rather than from the increasing value of the issuers’ share price. This reflected our view that bond-like convertibles offered the most attractive opportunities as markets recovered from the aggressive sell-off in credit-sensitive bonds in late 2015. As a consequence, the portfolio as a whole had lower levels of equity sensitivity than in earlier years, but was well placed to participate in the improvement in credit conditions that took place in 2016.
Following a period in which we benefitted from these improving credit conditions, we started to make the portfolio more defensively positioned in the third quarter of 2016, in the belief that the potential risks were becoming increasingly skewed to the downside. We retained a positive longer-term view but were increasingly concerned about a near-term correction as opposed to a prolonged downturn. As a result, we sought to take profit on credit exposures that we considered to be fairly valued, particularly where we saw no indications of the potential for improving credit conditions resulting from the issuing company’s own initiatives.
By contrast, we were happy to retain exposure to higher yielding positions where we felt that the actions being taken by the company to improve its credit profile left it better placed to withstand a potential correction. In place of the positions that were sold, we brought in higher quality bonds trading closer to their fixed income values, with the aim of protecting the portfolio going into a period of heightened political risk.
In the event, robust economic data and the result of US Presidential election ushered in market expectations of heightened inflation and a belief that the US would embark on a series of expansionary fiscal policies, which would moderate the economic risks associated with the withdrawal of supportive monetary policies and an increase in US interest rates.
We viewed these events as reducing the likelihood of a market correction in the near term and so reverted to a view that was more positive towards risk assets, including corporate bonds, convertibles and equities as the US economy remained some distance from recession.
Nevertheless, we retained our caution on valuations in credit markets and continue to believe that the tightness of credit spreads is likely to limit total returns over coming years to the coupon income received. In particular, we felt that the tightness of credit spreads was likely to limit the degree to which bond-like convertibles were able to generate returns from rising equity markets. As a result of this, we sought to add risk to the portfolio by increasing its exposure to more balanced convertibles offering greater direct sensitivity to increases in equity prices. We were able to refocus the portfolio on these names as a result of our flexibility to invest with the total return of the portfolio in mind, rather than purely its capacity to generate income. Even so, we remain committed to supporting the revenue account of the Company and ensured that all balanced positions were acquired at levels that ensured a positive hold-to-maturity return even in the event that equity markets subsequently underperformed.
These positions added value through the first half of 2017, as equity markets continued moving higher despite some questioning of the global economy’s ability to meaningfully in the absence of continuing loose monetary conditions. As time passed and valuations become further extended, however, and we have begun taking profit on some of these positions, with particular emphasis on reducing our exposure to holdings most exposed to the equity price of the issuer and priced well above their bond floors, being the level at which we anticipate that a security’s behaves less like an equity and more like a bond, protecting us from losses that would accrue if the price of the issuer’s equity fell. As in the third quarter of 2016, we are currently seeking to balance the desire to retain exposure to continued advances in equity and credit markets, whilst being increasingly focused on protecting the portfolio on the downside.
As a result of this, we have been considering the opportunity for new instruments and positions with the potential for asymmetric returns; instruments that allow us to participate in any further rises in equity markets with limited risk to capital should markets fall. This has caused us to again focus on those positions where we have the greatest belief in the strength of downside protection, either through the strong credit quality of the issuer or the short maturity of the security.”
JGCI : JPMorgan Global Convertible benefits from discount tightening