The case for convertibles in 2018

A new year has begun, and investors are hoping for a repeat of the strong returns enjoyed in 2017. But in one key area investors face a familiar dilemma, which they’ve endured for the last nine years: finding income in a still low yield environment without taking on too much risk. Although the yield of a 10-year U.S. Treasury bond has risen recently to around 2.50%—that’s not too far from where it was at the beginning of 2017 (source: Bloomberg, as of 1/10/2018). And, as the BlackRock Investment Institute’s Jean Boivin noted recently, a range of secular factors is likely to keep a lid on a sharp increase in rates for some time to come.

Still, the Federal Reserve (Fed) raised its benchmark interest rate again in December, and we do expect rates to grind higher in 2018. Against this backdrop, some investors are taking a look at convertible bonds, which are debt instruments issued by a company that can be converted into stock of the same company. They are a sort of hybrid investment vehicle, combining attributes of both stocks and bonds.

Convertibles have characteristics that potentially augur well in the current environment. They can offer the growth potential of stocks, a possible plus at a time when the economic environment and earnings are generally supportive of equities, as we’ve seen with the steady rise in indexes across most asset classes. But they historically have lower equity beta and bond-like characteristics that may help provide some protection in downturns, where they have tended to exhibit less downside capture. Note, for example, how they performed during the “taper tantrum” in 2013.

Additionally, with many investors focused on credit risks, particularly in high yield, convertibles may be more favorable relative to spread products. Historically, convertibles have had lower default rates than high yield bonds, according to research from Barclays.

There’s more. The sector breakdown of the Bloomberg Barclays U.S. Convertibles: Cash Pay Bond Index currently has a large exposure to equity factors and sectors we are positive on, namely the momentum factor and technology, which comprise nearly half of the index (source: Bloomberg, as of 1/10/2018). And while these exposures can change, convertibles can be a way to access tech and biotech-type momentum names while managing risk and accessing yield potential. The index has a 12-month trailing yield of 2.18%, which is roughly similar to the Bloomberg Barclays U.S. Aggregate Bond Index’s 2.33% yield and is higher than the S&P 500’s 1.78% (source: Bloomberg, as of 1/4/2018).

Convertibles have generally performed well in periods of rising interest rates, as well as in market shocks like the taper tantrum (source: Bloomberg, as of 1/10/2018). In other words, convertibles are uniquely positioned to offer the growth potential of stocks, but with the income and downside risk management characteristics of traditional bonds.

Bottom line: It may be time for some investors to consider convertibles in their asset allocation in 2018. iShares Convertible Bond ETF (ICVT) could be an option.

Chris Dhanraj is the Head of the ETF Investment Strategy team in iShares and a regular contributor to The Blog.

Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities. Convertible securities are subject to the market and issuer risks that apply to the underlying common stock. The methodology of the index that ICVT seeks to track does not provide for the conversion of the convertible bonds in the index and ICVT is not obligated to exercise the conversion feature associated with those securities, even if it is economically beneficial to do so. Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market. When comparing stocks or bonds and iShares Funds, it should be remembered that management fees associated with fund investments, like iShares Funds, are not borne by investors in individual stocks or bonds. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader. The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision. This post contains general information only and does not take into account an individual's financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision. The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”). The iShares Funds are not sponsored, endorsed, issued, sold or promoted by Barclays or Bloomberg Finance L.P., nor do these companies make any representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with the companies listed above. ©2018 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. 366376

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