Convertibles rally 4.55% in March, driven by equities; volatility flat or lower: Barclays analysts

By Rebecca Melvin

New York, April 6 - The convertible market rallied 4.55% in March, driven mainly by strong showings in equities and incremental momentum from credit, according to Barclays Capital equity-linked analyst Venu Krishna and convertibles research analysts Manoj Shivdasani and Peng Cheng.

The rally followed a positive 2.68% move in February.

In equities, the S&P 500 index was up 6% in March, while the Nasdaq notched a 7.2% gain and the small-cap Russell 2000 index was up 8.14%.

Of the convertibles universe, mandatories were the best performers, up 8.7%, while bond structures were up 4.07% for the month, the analysts wrote in their monthly market watch report.

The HFRX Convertible Arbitrage index was up 2.48% in March, and in the year to date, the index has returned 2.28%, underperforming the Barclays Capital U.S. Convertibles Composite index's return of 5.62%.

Spreads tighten

Non-investment-grade convertible bond spreads tightened sharply to 700 basis points from 787 bps, whereas the Barclays Capital U.S. High Yield 'B' index tightened 84 bps to 540 bps from 624 bps.

Investment-grade convertible credit spreads contracted to 189 bps from 225 bps, while the Barclays Capital U.S. Credit index tightened to 136 bps, down 22 bps from 158 bps a month ago.

The spread between non-investment-grade convertibles and the Barclays Capital High Yield 'B' index contracted to 160 bps from 163 bps a month ago.

Implied volatility flat

Implied volatility of investment-grade convertibles with at least one year of call protection ended March at 31.9%, which was flat from 31.8% at the end of February.

Option surface volatility lowered marginally to 31.4%, down from 32.2% a month ago.

And 90-day realized volatility fell to 27.7% from 31.1%.

Meanwhile, the VIX continued to decline from 19.5% at the end of February to 17.6% for March.

The Barclays Capital 2010 U.S. Recommended Portfolio was up 4.90% in March, outperforming the Barclay Capital U.S. Convertibles Composite index's 4.55% rise.

Primary picks up

Issuance in the market finally picked up, with 14 deals totaling $4.8 billion priced in March. The volume was the third highest in the last 12 months. However, for the year to date, annualized volume of $27.5 billion is still below average, historically, the Barclays Capital analysts wrote in their monthly new issue trends report.

Organic growth was positive at $2.55 billion for the month, bringing year-to-date organic growth to $1.4 billion.

Pricings on the new issues were very tight with an average cheapness of 1.78% not including Corporate Office Properties Trust and Cemex SAB de CV, the lowest in the last 12 months. One-day average delta hedged return was 1.32%, the highest since October, reflecting demand in spite of aggressive pricing.

Eighty-six percent of March's new issues were non-rated. ProLogis was the only investment-grade issue (BBB-). The other rated issues were International Coal Group Inc. and Group 1 Automotive Inc. (both B-).

Large-cap issuers made up 37% of last month's volume and 44% of the volume in the year to date.

Issuers in the financial sector accounted for the lion's share, or 40%, of new issuance in March, followed by information technology's 23% and materials' 18%.

For the year to date, financials accounted for 43.5% of new issuance.

Yields low, premiums high

The weighted-average yield was 3.9% in March, the second lowest in the last 12 months. On the other hand, the average premium was 27.2%, the second highest in the last 12 months.

Weighted average yield spiked up in December, but it has been gradually moving lower for the last year from about 5%.

Weighted average premium has been mostly steady, but it rounded higher in the second half of 2009 before slipping in January and February.

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