In this fixed income market intelligence column, our experts discuss the fixed income vehicles to equities.

1. The fixed income
vehicle to equities
Tarek Saber
Head of Convertible Bonds & Lead Portfolio Manager
Convertible Bonds

2. The current low-yielding investing world has created an environment in which the upside of “safe” fixed
income investments has become limited, while market volatility is making equity markets allocations too
risky for many investors. Against this landscape, convertible bonds offer an attractive alternative.
Convertible bonds are corporate bonds that may be exchanged by the
holder for a fixed number of ordinary shares. They can be regarded as
a combination of a fixed income instrument and a stock option, with
the bond limiting downside risk and the option providing equity
participation. Convertibles increase in value alongside equities in rising
markets, while being protected from the inevitable sharp declines --
the value of the underlying bond provides a floor value and prevents
the market price from falling with equities past a certain level. This
bond-floor “parachute” makes convertibles a less painful way of
participating in a company’s equity when things go wrong. Moreover,
convertibles have proven that they can perform with a lower volatility
than equities, and their option-like characteristics enhance their
valuations in times of equity market volatility.
Well-kept secret
Still, convertibles have been overlooked by many investors. The asset
class has developed significantly in the recent years but much
misplaced fear and confusion persists. Concerns about a lack of
convertible issuance appear unfounded; the market for convertibles is
renewing itself at a normal rate of about USD100 billion a year.
Another issue is whether convertible investments should be treated as
an equity or fixed-income allocation. Convertibles should be seen as
an entirely separate allocation that bridges the two classes, and
investors might best view con-vertibles in terms of what contribution
they can make to a portfolio as a whole.
For example, investors whose portfolios are limited to fixed income can
use convertibles to gain equity exposure. For insurers and other
investors with solvency constraints, convertibles’ uncorrelated returns
has gained them favourable treatment under the European Union’s
Solvency II rules. With the size of the global convertible market at
about a quarter of that of the global high-yield market – which has a
separate allocation in almost all institutional mandates – there is a
strong case to be made for a dedicated convertibles allocation. Many
companies limit their bond issues to convertibles. By excluding
convertibles from their portfolios, bond investors in effect exclude
these companies; conversely, convertibles can be seen as adding a
dimension of diversification.
Investment philosophy
NN Investment Partners bases its investment philosophy on two
convictions. One is that convertible bonds provide asymmetrical
returns, as well as equity-like returns with lower volatility over the
economic cycle. The second conviction is that we can enhance these
benefits and outperform the convertible bond asset class. We do this
by selectively investing in convertible bonds with a clear and rigorous
four step process that involves investment in convertibles that offer
equity participation, combined with research-driven credit selection
for capital preservation, disciplined portfolio construction and strict
risk control.
The scope of our investment universe is global, and the goal of our
investment process is to single out the best investment vehicles issued
by the most attractive companies related to our selected themes
regardless of their region or sector. By using themes rather than
sectors, we make use of dynamic rather than fixed stock classifica-
tions that add clarity to what is driving companies valuations going
forward. Our aim is to construct a portfolio of balanced convertible
bonds that is well diversified from a name, sector and theme
perspective. In an ideal world, performance over the cycle would come
from a broad set of themes. Themes that have worked particularly
well in the past are Memory Chip Cycle, US Consumer Spending, Real
Estate Exposure and Health Care Spending. Our five biggest themes
are currently Cloud computing, Corporate Rationalisation, Healthcare
spending, Bank Deleveraging and Electronic Components.
NN Investment Partners does not simply invest in convertible bonds.
We invest in companies, using convertibles as the vehicle through
which to access them. This distinction should serve to reflect the
discipline that our team tries to bring to the investment process as a
whole, a process that leads to a concentrated portfolio of around 30
holdings.
Tarek Saber
Head of Convertible Bonds &
Lead Portfolio Manager
Convertible Bonds

3. About NN Investment Partners
NN Investment Partners is the asset manager of NN Group N.V., a publicly traded corporation. NN
Investment Partners is head-quartered in The Hague, The Netherlands. NN Investment Partners
manages in aggregate approximately EUR 180 bln* (USD 202 bln*) in assets for institutions and
individual investors worldwide. NN Investment Partners employs over 1,200 staff and is active in 16
countries across Europe, Middle East, Asia and U.S.
As of April 07, ING Investment Management has renamed to NN Investment Partners. NN
Investment Partners is part of NN Group N.V., a publicly traded corporation. Currently NN Group is
25.8% owned by ING Group. ING intends to divest the remaining stake in NN Group before 31
December 2016, in line with the timeline ING has agreed with the European Commission.”
*Figures as of 30 September 2015
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