Merrill convertible index off 4.4% for 2001 with underlying stocks down 18%

By Ronda Fears

Nashville, Tenn., Jan 3 - The Merrill Lynch & Co. convertible index was down 4.4% for 2001 against a whopping 18% drop in the underlying shares, which the firm's convertible analysts said proves that a lack of equity sensitivity can be quite beneficial in a very rough year. However, low delta meant serious lagging in the fourth quarter rebound, when converts gained only 7% while the associated stocks advanced 18.7%.

"The year's most interesting lesson was that busted can be beautiful given the right market conditions," said Merrill convertible analysts Anne Cox and Anne Elliott in a report Thursday.

Yield-oriented convertibles, or busted issues, with a delta below 0.4 were the year's head-turner with a gain of 10%, outperforming high-grade issues that were up 8.4% and high-yield issues that were up 5.5%, the report showed.

Spurred by the Enron debacle, utility converts had the largest negative sector decline, falling 38.2% in 2001 and taking about 183 basis points from the master index return as the group had a 4.8% weight in the index, the analysts said in the report. Technology with a 25.8% weight converts had a relatively mild 6.9% full-year decline, but hurt the master index almost as much, the analysts noted, pulling the index back about 179 basis points.

The tail end of a very rough year yielded very positive numbers in the U.S. equity markets and, to a lesser degree, convertibles participated in the rebound. The Nasdaq composite's gain of 30.2% in fourth quarter was evidence of optimism, the analysts said in the report, yet was unable to undo the year's damage, leaving the benchmark down 20.8% for 2001. Stocks underlying the Merrill U.S. convertibles index were in line with the trend, up 18.7% for the quarter, however low delta resulted in a mere 7% total return for the convertibles themselves.

Speculative-grade converts gained nearly 10% for fourth quarter, versus a 3.6% gain for investment-grade. Credit spreads tightened more than 200 basis points in the single-B range over the fourth quarter, the analysts said, and about 20 basis points in the single-A range. For the full year, however, speculative converts were down 7%, suffering from their underlying stock mix, while high-grade converts fell only 2.7%, the report showed

Growth convertibles' stellar comeback in the fourth quarter put the group down only 3.2% for the full year, compared with a 6.4% loss for value issues. That was in sharp contrast to the first three quarters of 2001, the analysts noted, in which growth issues lagged value by more than 440 basis points. Growth converts gained 10.3% in fourth quarter and value converts gained 1.5%.

Contrasting the fourth-quarter out-performance of the small cap Russell 2000 (up 21.1%), small cap convertibles lagged for the quarter, up only 1.9%, versus a 9.9% gain for mid cap converts and a 6.3% gain for large cap converts.

"The equities are not to blame. The stocks underlying the small cap index gained 23.2% for the quarter," the analysts said in the report. "The small cap index has become practically synonymous with sketchy credits (average implied rating around CCC+), and with a weighted average delta of 0.28 (vs. 0.43 for the broad index) members have been reacting to catalysts other than stock performance. However, small cap comprises only 6% of our broad universe, meaning the group's woes were not widely felt."

The year's most interesting lesson was in busted converts (up 10%), the analysts said.

"Yield converts managed to outperform both high-grade (+8.4%) and high-yield (+5.5%) straight bonds for FY2001. By contrast, total return plays dropped 1.3%, and equity plays fell 32.0% for the year," the analysts said in the report.

"Worth noting, however is December's bias toward equity plays. They were up 4.5% vs. a 2.3% gain for total return and a 1.4% gain for yield. If December is an indicator of improved optimism, yield's winning streak is likely to become nothing more than last year's news."

End

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.