Convertible Bond Volatility: How Public Funds Mine Profits

The "zero default" history of convertible bonds did not lead to a significant reduction in public fundraising for this type of asset at the end of the second quarter, with the weight of such assets in the bonds held by public fundraising remaining essentially unchanged on a quarter-over-quarter basis.

As an important institutional investor in convertible bonds, public funds have focused their allocation on convertible bonds in sectors such as banking, electronics, power equipment, automobiles, and public utilities.

After entering the third quarter, the market for convertible bonds has experienced fluctuations.

Advertisement

As of August 27th, the CSI Convertible Bond Index has risen by -5.55% for the quarter, following the -7.94% of the first quarter of 2022.

However, unlike the first quarter of 2022, the reasons for the adjustment in the convertible bond market this time, from the perspective of institutional views, are not only due to the decline in their prices with the stock market but also due to the end of the "zero default" of convertible bonds and the downgrade of ratings, which has led to market concerns about their credit risk.

In terms of public asset allocation, the default of convertible bonds in the late second quarter did not lead to a significant reduction in this type of asset.

By the end of the second quarter, the market value of convertible bonds held by public funds was 276.1 billion yuan, a quarter-over-quarter increase of 1.53%, and its proportion in the bonds held by public funds only decreased by 0.06 percentage points.

From the perspective of the market, even if convertible bonds have fluctuated, public funds have basically chosen to stick to their positions, playing an overall "ballast stone effect."

However, from the perspective of the sub-market, including stock-oriented funds and secondary hybrid bond funds, there are not a few funds that have reduced their holdings of convertible bonds in the second quarter, but the impact of their reduction has been somewhat offset by the increase of primary hybrid bond funds and medium to long-term pure bond funds.

Even within the convertible bond itself, there is a division according to the industry, with convertible bonds from the banking, power equipment, electronics, and automotive industries being increased, while those from the agriculture, forestry, animal husbandry, and non-bank financial industries are being reduced.

Sporadic defaults and a few downgrades of ratings, as an asset with both debt and equity characteristics, the market performance of convertible bonds is largely affected by the stock market.

According to data from East Money Choice, as of August 27th, the CSI Convertible Bond Index has risen by -5.55% since the third quarter, following the -7.94% of the first quarter of 2022.

In the third quarter of 2024 and the first quarter of 2022, the Shanghai Composite Index has risen by -4.00% and -10.65%, respectively.

However, the difference is that in the first quarter of 2022, the performance of the convertible bond index was 2.71 percentage points ahead of the Shanghai Composite Index, while in the third quarter of 2024 it was 1.55 percentage points behind.

Since 2024, some convertible bonds have defaulted.

On April 30th, "Soutec Bond" issued a default announcement stating "it is expected that the principal and interest of the redemption will not be paid," becoming the first convertible bond in history to default.

On June 3rd, "Hongda Bond" issued a similar announcement.

Subsequently, "LanDun Bond," "Lingnan Convertible Bond," and others have also announced defaults.

"Guanghui Convertible Bond" is another form of default.

Due to the stock closing price being below 1 yuan for 20 consecutive trading days, Guanghui Automobile has issued 11 "Risk Warning Announcements on the Possible Termination of Listing of the Company's Stock and Convertible Corporate Bonds" since June 21st.

In the end, the company's stock and convertible bonds were delisted and de-registered on August 28th.

In addition to defaults, some convertible bonds have also experienced rating downgrades.

East Money Choice data shows that as of August 21st, 47 convertible bonds have been downgraded since 2024, of which 40 were in the second quarter and 3 in the third quarter.

Among them, there are not a few consecutive downgrades, such as Lingnan Convertible Bond, which was downgraded from "A" to "A-" on February 7th, and was downgraded 7 times in March, May, July, and August, with the latest rating on August 15th already reduced to "C." The decline also means opportunity.

In the words of the fixed income team of Industrial Securities, the above phenomenon (sporadic defaults and a few downgrades) leads to "a decline in the overall market quality expectations."

In their view, the current pricing of convertible bonds includes pessimistic expectations, the pure bond premium rate of balanced convertible bonds is already at the lowest level in history, and the "default rate" expectation contained in debt-oriented convertible bonds is at the highest level in history.

Moreover, whether it is the number of convertible bonds that have defaulted or the number of downgrades, compared to the overall number of convertible bonds exceeding 500, the former is almost negligible, and the latter accounts for less than 10%.

Wind data shows that as of August 29th, there are 234 public convertible bonds on the Shanghai Stock Exchange, with a public balance of 497.612 billion yuan, and 304 public convertible bonds on the Shenzhen Stock Exchange, with a public balance of 288.756 billion yuan.

Ballast stone effect From the perspective of public asset allocation, the investment value of convertible bonds is prudently assessed due to the exposure of credit risk, but overall, there has been almost no reduction.

According to East Money Choice data, as of the end of the second quarter, the market value of convertible bonds held by public funds was 276.1 billion yuan, a quarter-over-quarter increase of 1.53%, and its proportion in the bonds held by public funds only decreased by 0.06 percentage points.

Looking at the second quarter, public funds account for more than one-third of the convertible bond market stock, and are very important institutional investors.

Moreover, the main reason for the weight reduction is that public funds increased the allocation of bond assets in the second quarter, with the market value of bonds held increasing from 1.69 trillion yuan at the end of the first quarter to 1.79 trillion yuan, an increase of 5.85%, exceeding the growth rate of the market value of convertible bonds held by 4.32 percentage points, thus causing the latter's proportion to decline relatively.

However, if the cycle is extended, it will be found that since 2018, the overall allocation of public funds to convertible bonds has been an increasing trend.

Data shows that in the four quarters of 2018, convertible bonds only accounted for 0.68%-0.84% of the market value of bonds held by public funds, in 2019 it was at the level of 1.00%-1.30%, in 2020 it was at the level of 1.27%-1.80%, in 2021 it was at the level of 1.59%-2.05%, in 2022 it was at the level of 1.87%-2.05%, and in 2023 it has been at the level of 1.98%-2.12%.

As for whether this increasing trend will be broken this year, it remains to be further observed.

Zhang Hui, the fund manager of Huafu Hongxin Fund, wrote in the second-quarter report looking forward to the third quarter: "After the decline in June, the pricing of credit default rates for convertible bonds is at a historical high, and the pricing level of low-priced bonds is in an unreasonable range.

In the future, as the liquidity of the convertible bond market recovers, rational pricing may gradually return... From a medium-term perspective, the probability of winning assets in convertible bonds is relatively large."

Huafu Hongxin is a flexible allocation fund, belonging to equity products, with 70% of its assets allocated to bonds at the end of the second quarter, of which convertible bonds accounted for nearly 30%, and at the end of the first quarter, 86% of its assets were allocated to bonds, of which convertible bonds accounted for nearly 60%.

Adjusting the product structure However, it is precisely by adjusting the product structure, as well as the industry structure of the convertible bonds held, that public funds have stabilized the level of allocation of convertible bonds and played the role of a "ballast stone."

According to East Money Choice data, the main force of convertible bond allocation is mainly secondary hybrid bond funds, primary hybrid bond funds, and debt-oriented hybrid funds, with the market value of convertible bonds held in the second quarter being 149 billion yuan, 64.4 billion yuan, and 28 billion yuan, respectively, accounting for 53.97%, 23.31%, and 10.16% of the market value of convertible bonds held by public funds, with a total of 87.43%.

Among them, primary hybrid bond funds are the main force of increase, with the market value of their holdings increasing by 12.02% quarter-over-quarter, and their weight increased by 2.18 percentage points.

Secondary hybrid bond funds and debt-oriented hybrid funds have slightly reduced their holdings.

In addition to primary hybrid bond funds, medium to long-term pure bond funds are also the main force of increase, with the end-of-period holding market value of 13.9 billion yuan, a quarter-over-quarter increase of 46.39%, and their weight in the market value of convertible bonds held by public funds increased from 3.49% at the end of the first quarter to 5.03%, an increase of 1.54 percentage points.

Other types of funds, such as stock-oriented hybrid funds, common stock funds, FOF, and bond index funds, have not changed much in the allocation level of convertible bonds in the second quarter.

Convertible bond theme funds (names containing "convertible bonds") are also the main force of increase, with the market value of convertible bonds held increasing from 37.8 billion yuan at the end of the first quarter to 50 billion yuan, an increase of 32.28%, and the market value held by non-theme funds decreased from 234.2 billion yuan to 226.1 billion yuan, a decrease of 3.46%.

According to the classification of the industry of the underlying stocks, among the convertible bonds held by public funds at the end of the second quarter (with a market value of 259.3 billion yuan), the weights of the banking, power equipment, and electronics industries are ranked in the top three, accounting for 28.86%, 10.26%, and 6.88%, respectively.

From the perspective of weight changes, public funds mainly increased the allocation of convertible bonds in the banking, electronics, power equipment, automotive, and public utility industries in the second quarter, with their end-of-period weights increasing by 0.22, 0.49, 0.30, 0.39, and 0.21 percentage points respectively compared to the end of the first quarter, while reducing the allocation of convertible bonds in the agriculture, forestry, animal husbandry, non-bank finance, construction decoration, petroleum and petrochemical, and mechanical equipment industries, with the latter's weights decreasing by 0.41, 0.49, 0.21, 0.18, and 0.19 percentage points respectively.

By the end of the second quarter, the top three convertible bonds held by public funds in terms of market value were Pudong Development Bank Convertible Bond, Industrial Bank Convertible Bond, and Nanjing Bank Convertible Bond, with market values of 15.4 billion yuan, 13.8 billion yuan, and 8.4 billion yuan, respectively, all of which belong to the banking industry.

From the perspective of fund managers, there were 147 public institutions holding convertible bonds at the end of the second quarter, a decrease of 4 from the end of the first quarter.

Including BlackRock, East Alpha, Hive, Shangzheng, and Yimi Fund, there are 5 public institutions that cleared convertible bonds in the second quarter, and at the same time, one institution, Schroders Fund, began to lay out this type of asset.By the end of the second quarter, the top three public mutual funds holding convertible bonds in terms of market value were Yifangda, Bosera, and Axa Fund, accounting for 13.42%, 7.60%, and 6.50% of the total market value held by public mutual funds, respectively.

Among them, the market value held by Yifangda and Axa Fund decreased by 3.12% and 14.57% month-on-month, respectively, while Bosera's market value increased against the trend by 31.87%.