DWS stresses need for inhouse convertibles ratings experience

DWS Investments is cautioning convertible investors to ensure their managers can assess unrated Asian issuers, as many funds boost exposure there as the region grows in index weightings.

Strong demand for Asian convertibles – the fastest growing region for such paper last year – meant many issuers did not need independent ratings.

Asia ex-Japan represents 12.2% of the ML Global 300 Convertible benchmark, but Christian Hille, manager of the €1.8bn DWS Invest Convertibles global fund predicted it will eclipse Europe’s 24.2% weight by 2015.

“Asia and EM exposure in convertible portfolios will grow. Companies in Asia have the luxury to issue non-rated paper due to high demand. DWS uses internal rating models to manage those convertibles.

“There is little history on the region’s companies so you have to take examine balance sheets, map numbers to similar companies in developed markets, and compare to US and European ratings.”

DWS employs these for its global balanced fund.

Hille also cautioned using ‘synthetic convertibles’, structured products built with options to resemble convertibles.

Some managers used them as the EMEA convertibles market contracted by €100m in the first quarter, after redemptions were netted off against new issuance.

Hille said using them can “can deteriorate the DNA of a fund because you do not buy long-dated optionality of a convertible, instead you must buy short-dated options and that has underlying risks like roll-risk.”

Hille said, as a rule of thumb, DWS’s convertible fund aimed to capture two-thirds of equity market rises, while avoiding one third of the falls.

While Japanese equities plunged up to 30% after Japan’s recent disasters, DWS Invest Convertibles’ Japanese exposure fell on average 7% to 8% for lower delta names, where the manager has a higher weighting, while for its higher delta names the fall was 15%.

Hille recently trimmed energy company paper and “structurally expensive” European issues. He bought defensive US consumer staples, pharmaceuticals and healthcare, and telecoms convertibles, to benefit from America’s growth, and to close in on the benchmark’s 49.4% US weight.

He said as convertibles recovered post-crunch, managers could safely take broad-based exposure to high grade and high yield issues.

“Now, we already see early signs in high yield there is idiosyncratic risk, and distinctions made by ratings quality. You need a lot more bottom-up due diligence.”

Hille said his investors were a mixture of equity investors seeking cushioned exposure to shares, and credit investors wanting diversified global exposure.

David Walker

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