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Convertible bonds: Leverage and structure risk return for convertibles

Convertibles are attractive but illiquid; Investors are desperate for new issues

So much money is now looking to be invested in the fast-recovering convertible bond market that it faces evident danger of overheating, according to participants. Investors are once again using leverage to increase their returns as bonds become more expensive and harder to trade in the secondary market. Investors are desperate to put on exposure through new issues and it seems likely that before much longer there will be an accident in the primary market.

"The transaction shows that if you are a well-known and hedgeable credit and benefit from a liquid stock then, even if you are sub-investment grade, the equity-linked market can be receptive in size"

Antoine de Guillenchmidt, Morgan Stanley

Antoine de Guillenchmidt, Morgan Stanley

The equity-linked sector of the capital markets cratered badly at the end of 2008, as financing was withdrawn from the key hedge fund investor base. As recently as March, many long-only convertible funds were 80% invested in cash. But the market has rebounded quickly and strongly so far in 2009. By mid September, the Goldman Sachs S&P sector-weighted convertible bonds basket was up 25% for the year, compared with just a 16% increase for the S&P 500 index itself.

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