Merrill analyst says convertibles supported by fixed-income component in February

By Ronda Fears

Nashville, March 4 - The bond market and the richness of convertibles helped the asset class maintain flat returns in the face of declining stocks, Merrill Lynch & Co. convertible analyst Marc Malloy said in a report Tuesday.

"Buoyed by their fixed-income components and a decrease in their discount to theoretical value from 1.33% cheap as of Jan. 31 to 0.98% as of Feb. 28, U.S. convertibles lost only 0.2% despite a 3.1% decline in their underlying stocks," he said in the report.

U.S. convertibles lead all equity benchmarks year to date, he added.

The Merrill convertible index is up 1.36% year-to-date through the end of February. Year-to-date, the Nasdaq is up 0.25%, while the Dow Jones Industrial Average is down 5%, the S&P 500 down 4.08% and the Russell 2000 down 5.69%.

Speculative-grade convertibles managed to eke out a slight advantage over their investment-grade counterparts during February, the analyst said. Speculative-grade issues retracted 0.2% as their underlying equities deteriorated 3.9%. Investment-grade converts lost 0.3% as their corresponding stocks dropped 1.8%.

Merrill Lynch's high-yield corporate bond index gained 1.3% and the corporate bond master index was up 2.1% in February, Malloy noted.

Growth convertibles gained 0.1% as their underlying stocks lost 1.7% in February.

Value converts declined 0.7%, but fared well compared to their underlying equities, which dropped 4.8%.

Yield alternatives, with deltas 0.4 and lower, were the big winners, Malloy said, noting these issues account for 69.2% of the convertible universe. The group gained 0.8% despite their underlying equities losing 2.7%. Yield convertibles had a delta of 0.12 at the end of February.

Small-caps displayed little equity sensitivity as the sector gained 0.4% while their underlying equities declined 6.4%.

Large-cap converts lost 0.5% in February as their corresponding stocks dropped 2.5%, which is less than their 0.31 delta would indicate.

For the second straight month, the tech sector outperformed all other sectors in the convertible universe both in terms of absolute and relative performance, Malloy said.

Propelled by strong gains from Xerox and Corning, the tech sector gained 0.9% as underlying stocks dropped 0.3%.

Led by gains in Amgen, ImClone and Sepracor, healthcare converts posted a 0.4% increase in February despite a decline of 3.8% in the underlying equities. The sector accounts for 16.1% of the market value of the Merrill master convertible index.

Utilities were the worst performing sector in February.

Sharp declines in Duke Energy's two mandatories were a factor in the utility sector's decline of 3.9% during the month, versus the 9.1% decline in the sector's underlying stocks.

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