Fitch Ratings says in a new report that equity will be the main driver of convertible bond (CB) funds' performance in 2014, with volatility as a supplementary factor, as the sector continues to attract strong flows from institutional investors.

This shift by CB funds towards an equity profile reflects a tactical positioning as well as the increasing proportion of equity-like CBs relative to hybrids in the market. The evolution of funds from a "balanced" to an "equity like" profile may reduce asymmetry of returns (ie. convexity).

CB funds have continued to experience strong inflows so far in 2014 from institutional investors who are looking to add equity exposure to their fixed income portfolio, extending a trend seen last year. Most flows went to global funds which represent around 50% of the total CB fund universe. However, relative to assets under management (AUM), flows were roughly evenly split between regions. In total, CB's AUM grew about 40% since January 2012.

Demand exceeds supply on the small USD450bn CB market. "Imbalances between supply and demand on the CB market challenge the ability of portfolio managers to build positions at an attractive price and diversify portfolios while remaining selective," says Manuel Arrive, Senior Director in Fitch's Fund and Asset Manager Rating team.

Managing capacity is becoming an issue for large funds, but Fitch has not found any evidence that size impaired performance. The agency expects synthetic instruments and options to be increasingly used to mitigate size and supply constraints.

The report, "Convertible Bond Funds Dashboard April 2014", is available at www.fitchratings.com or by clicking on the link below.
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=745136

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