Investors were rocked by a drop in the price of convertible bonds issued to the peak of the market this year, as fears of higher inflation pushed interest rates up and rocked the value of debt.
Big tech groups like Twitter, Peloton and Airbnb took advantage of strong demand to issue convertible bonds just before sentiment changed. Convertible bonds are sold in the form of debt but can be exchanged for stocks if the value of a company increases to a specified strike price, which means that these securities can be affected by fluctuations in the stock markets or fixed income securities.
The declines to these convertible bonds illustrate just how much Wall Street investors are grappling with the risk of a price hike and growing concerns that tech trading that has generated outsized returns since the market bottom. in March 2020 ran out of steam.
“It’s a double whammy,” said Peter Sheehan, credit strategist at Loomis Sayles, whose multi-sector income fund has more than 6% of its cash in convertible bonds, including transactions from Twitter and Peloton.
The sentiment was so strong earlier this year that several companies were successful in selling zero coupon bonds, meaning they don’t have to pay interest on the debt, as well as a high strike price. which reduces the dilution potential of existing shareholders.
However, as inflation fears intensified as the economy rebounded, convertible bond prices fell as higher interest rates eroded the value of debt and stock prices of tech companies.
These concerns have triggered an exodus of convertible bond funds. In the week to May 12, the category recorded the biggest outings since November, with investors globally pulling in a net $ 530 million, according to EPFR data.
“What happened? Rates went up and conversions were slammed,” said John McClain, portfolio manager at Diamond Hill Capital Management, who said he was buying back the debt now that prices had fallen.
Peloton’s zero-coupon bond sold in February was trading as high as 110 cents to the dollar, but has since fallen to just 93.5 cents. Airbnb’s bond since early March fell to 92.5 cents and the Twitter convert sold around the same time fell below 90 cents this month before falling back slightly. All three notes expire in 2026.
In turn, this pushed the convert yield higher. Twitter’s convertible bond now earns more than 2%.
The rise in Treasury yields has also put pressure on the stock prices of some of the once-high-end growth stocks on Wall Street considered to be more sensitive to tighter financial conditions. When a company’s stock price declines, the strike price that must be met for a convertible bond to turn into stock moves further away from the money, making it less attractive to investors to hold the bond. note.
Airbnb, Twitter and Peloton stock prices have fallen at least 20% since early March.
Nonetheless, new convertible bond issuance remained at record highs, with companies selling more than $ 95 billion in convertible bonds globally this year through May 25, the highest for this time of year. since Refinitiv started tracking data. More than $ 60 billion has been issued in the past three months alone, with Coinbase bringing the latest successful deal, at $ 1.25 billion, to market last week.