- Fixed Income Portfolio Manager
United States, Institutional
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While stocks and bonds comprise most of the public capital markets, there’s a large, growing universe of securities sitting in between these traditional asset classes. Capital securities — an eclectic group worth more than US$1 trillion globally — include various types of hybrid securities that share both bond and equity characteristics and earn equity capital treatment. Structural nuances of each security determine how much capital treatment they might receive from a regulator or ratings agency, as well as how “bond-like” or “equity-like” each behaves (Figure 1).
Figure 1
Capital securities markets have grown over the last several years as corporations have diversified their funding sources beyond traditional asset classes. This trend has accelerated recently, particularly in the convertible bond, mandatory convertible preferred, and junior subordinated debt markets.
We believe this broadening of capital markets expands the toolkit available for investors and issuers alike as both parties can opt for the piece of the capital structure best fit for their purpose. Investors can determine whether they prefer more bond-like or equity-like exposure to a certain issuer. Issuers can decide how a given structure optimizes for specific needs, such as lowering interest expense, improving capital ratios, or minimizing dilution (Figure 2).
Figure 2
Investors able to move across the capital structure have a distinct advantage because market-specific dynamics can cause prices of certain types of securities to diverge from fundamentals, creating alpha opportunities. We find convertible bonds to be particularly compelling today as their prospect for equity participation compares favorably to the limitations of generally tight spreads and call constraints across most parts of corporate credit. We believe recent issuance trends will continue as both investors and issuers embrace the value in a broader array of capital markets.
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