Consider convertibles to hedge against the risk of rising interest rates

Robert L. Salvin, Co-Head of Corporate and Tax-exempt Credit, and Anthony J. Daigle, Portfolio Manager, 11/12/21

Interest rates may be poised to increase in coming quarters, posing a risk to rate-sensitive strategies. U.S. Treasury yields are already inching higher as the U.S. Federal Reserve begins to taper the pace of its bond purchases. It's time, in our view, to think about new ways to diversify a portfolio by supplementing traditional fixed income allocations.

Convertibles are an asset class worth considering. These hybrid securities have historically:

  • Performed better than investment-grade fixed income in rising-rate environments
  • Demonstrated the ability to complement a fixed income strategy while offering more attractive risk-adjusted return potential compared with a balanced strategy of stocks and bonds

Performance in rising-rate environments

Convertibles have historically performed better than traditional fixed income assets during periods of rising rates. Convertibles are typically less sensitive to interest-rate risk than other types of bonds. As hybrid instruments, convertibles have an embedded call option on the underlying stock, through which an investor can participate in the issuer’s underlying equity performance. At the same time, most convertibles are bonds that pay current income. This feature has contributed to their ability to dampen the effects of equity market drawdowns, barring major market shocks.

In past periods when the 10-year U.S. Treasury yield increased by more than 150 basis points, the Bloomberg U.S. Aggregate Bond Index had negative results. Convertibles (as measured by the ICE BofA U.S. Convertible Index) outperformed the Aggregate in each case and had significant positive returns in many of them. In most of the periods, convertibles’ performance was closer to that of the S&P 500 Index.

Performance during significant 10-year Treasury moves*

performance of indexes

*Includes upward moves of 150 bps or greater. Source: Putnam, as of 9/30/21. Past performance is not a guarantee of future results. Indexes are unmanaged and used as a broad measure of market performance. It is not possible to invest directly in an index.

Diversify a portfolio for better risk-adjusted return potential

Aside from their results in rising-rate periods, convertibles offer potential as a long-term allocation to complement a fixed income strategy. Convertibles have participated in much of the upside potential of equities, but with lower long-term volatility.

The efficient frontier illustration below shows the benefit of adding convertibles to an all-bond portfolio compared with a balanced portfolio of stocks and bonds. At almost every level of risk (as measured by standard deviation), a portfolio of bonds and convertibles offered more attractive performance than a portfolio of bonds and stocks.

Convertibles can help optimize portfolios

Convertibles can help optimize portfolios

Source: Putnam. Results are for 20 years ended 9/30/21. Portfolios are rebalanced quarterly. Bonds represent the Bloomberg U.S. Aggregate Bond Index; stocks represent the S&P 500 Index; convertibles represent the ICE BofA U.S. Convertible Index. Indexes are unmanaged and do not incur expenses. You cannot invest directly in an index. Past performance is not a guarantee of future results.

The current opportunity in convertibles

With the economy growing and inflation at higher levels, the Federal Reserve is beginning to taper its bond purchases and, during 2022, may begin to lift interest rates. These forces could push rates across the yield curve higher in coming years and pose a risk to fixed income performance. Now may be an opportune time to prepare a portfolio for the coming interest-rate environment. Convertibles may be an attractive asset class to complement a fixed income strategy as an alternative to a balanced strategy.

Contact Putnam to learn more. We have managed convertible securities for over 45 years.


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The ICE BofA (Intercontinental Exchange Bank of America) U.S. Convertible Index tracks the performance of publicly issued U.S. dollar-denominated convertible securities of U.S. companies. ICE Data Indices, LLC (ICE BofA), used with permission. ICE BofA permits use of the ICE BofA indices and related data on an “as is” basis; makes no warranties regarding same; does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the ICE BofA indices or any data included in, related to, or derived therefrom; assumes no liability in connection with the use of the foregoing; and does not sponsor, endorse, or recommend Putnam Investments, or any of its products or services. The Bloomberg U.S. Aggregate Bond Index is an unmanaged index of U.S. investment-grade fixed-income securities. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg’s licensors approve or endorse this material, or guarantee the accuracy or completeness of any information herein, or make any warranty, express or implied, as to the results to be obtained therefrom, and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith. The S&P 500® Index is an unmanaged index of common stock performance.