Convertible Arbitrage

The last two months of 2023 saw equity markets reverse course to a massive rally after entering October in a continuing downward drift from the prior quarter. They closed the year at a near-record high, with the S&P 500 up over 14% in that two-month period. This was driven largely by the Fed moving its focus to its full employment mandate after better-than-expected inflation data led them to reverse course on keeping interest rates higher for longer.

Convertible performance finished the year strongly. The U.S. convertible bond market returned 13.0% for the year, outpacing the global convertible market’s return of 11.3%. Europe’s 7.3% return and Japan’s 7.1% return were a drag on the global return.

Global issuance for 2023 was $79 billion, with $53.4 billion coming from the U.S. The fourth quarter was relatively slow, with a busy November issuance calendar of $9.9 billion sandwiched between the quieter months of October and December, with only $3.9 billion and $4.3 billion issued, respectively. The global convertible market size is currently $360 billion.

We expect there to be significant convertible debt issuance over the next few years. BAML is forecasting $90 billion of issuance in 2024, which should lead to healthy growth in the overall market based on the current maturity schedule. Peak years of issuance in the convertible bond markets in 2020 and 2021 have left an abnormally large maturity wall to be addressed over the next few years. It is expected that around 15% of outstanding convertible bonds will reach maturity in 2025 and nearly 25% in 2026.

In addition, as a consequence of rate increases over the past 18 months, we expect to see the return of many issuers that have not been active in the convertible market for some time – particularly higher quality issuers that have become accustomed to lower interest costs. We could see further issuance beyond the traditionally large tech and healthcare segments in 2024, as seen with the 2023 influx of utility issuance.