Salomon: Shrinking premiums, rising delta signal times to shift positions

By Ronda Fears

Nashville, Tenn., April 5 - While a defensive portfolio was obviously beneficial during tough times, the convertible market's increased equity sensitivity illustrated by rising delta and shrinking premiums signal a time to shift holdings. Thus, Salomon Smith Barney convertible analyst Adrian Miller said the firm's recommended portfolio will change dramatically.

"April will see material changes in the portfolio in the hope of being better positioned to participate in the expected rebound in the economy and consequent equity price advance," Miller said in a report Friday.

The convertible market participated in 40% of the upside move in the underlying common stocks, so the weighted average premium to conversion value shrank to 47.4% from 52.1% in February. Also, the market's weighted average delta predictably increased to 53.6% from 49.2% the month before.

Equity sensitivity comes at the expense of yield, but not by much. The weighted average yield of the convertible market ticked down slightly to 5.4% from last month's 5.6%.

Miller said the convertible market has not seen premiums this low since the middle of 2001, just prior to the market's third quarter dramatic decline when premiums eventually widen to 72% in September. As the case for conversion premiums, he said the weighted average delta levels are approaching levels seen during the middle of last year.

With the improvement of the market and the subsequent lowering of conversion premiums, Miller said the average percentage of the market considered equity-sensitive increased to 33% from last month's 27%. The largest movement came from the credit-sensitive category, he said, as its presence in the market fell to 39% from 43%.

The "typical convertible" classification decreased to 28% from 29%.

Although there were a few high profile blow-ups in March - Adelphia Communications, Sepracor and Viropharma - the convertible market did very well against the broader markets.

If you measure the convertible market's performance based on an unweighted geometric basis, Miller said the actual performance breadth was very healthy. Compared to the capitalization-weighted return of 3.2%, the 4.2% unweighted geometric return indicates the convertible market "was stronger than it may have initially appeared," he said.

The strongest industry segments of the market were consumer cyclicals, energy and utilities.

From the consumer spending side of the equation, Miller said the convertible market benefited handsomely from strength in names like Ford Motor, Gap and General Motors.

"With the prospects of the economy picking up, especially considering the recovery will most likely be lead by the industrials, the energy sector has begun to move up in anticipation of improving earnings," Miller noted in the report.

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