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A Boom Period for Convertible Bonds

Expect strong issuance to continue in 2019 for this niche area of the bond market.

Zachary Patzik: 2018 proved to be an exciting time for convertible bonds. These hybrid securities comprise a corporate bond--which can provide downside protection and typically includes a fixed coupon payment to holders--as well as an embedded option that allows for upside participation if its corresponding equity appreciates. Their unique structure made for a tale of two periods, and we saw both a boom and bust in 2018--much like the equity market. Through the first three quarters of the year, the ICE Bank of America Merrill Lynch All US Convertible Index rose by 14.2%, while the S&P 500 and Bloomberg Barclays U.S. Aggregate Bond Index gained 14.3% and 1.6%, respectively.

Economic and political concerns spooked the markets at the beginning of the fourth quarter, which contributed to the sharp sell-off to end the year. As expected, convertibles fared better than their equity counterpart and managed to post a 20-basis-point return in 2018. Meanwhile, the S&P 500 dropped 4%, while the Agg gained one basis point.