James Peattie is a senior portfolio manager at CQS, which is a London-based global asset management firm. CQS focuses on credit strategies and thus it is active in markets for bonds and bond-related securities, while its interest in convertible securities means it also has some involvement in equity markets.
James is responsible for CQS’ “diversified” and “long-only” strategies. The diversified strategy typically utilises a mix of CQS’ own credit funds and convertible funds while the long-only strategy has led to a selection of around eighty different securities issued by companies from various industries and countries.
Recently, James was out from London to meet existing clients, brief CQS representatives and perhaps to speak to some potential clients as well. During his time here, YieldReport was able to talk with James about convertible securities.
Convertible securities are, as the name suggests, convertible. Typically they start (and often end) as debt instruments but either the issuer or the holder has the right to convert them to equity securities, usually on the maturity date. A convertible security can be thought of as a bond which has a call option attached. The bond has a face value upon which interest is calculated and then paid. At maturity the bond is paid out as usual, unless the holder exercises the call option, which in effect “converts” the bond to a share. This combination of debt and equity characteristics is the reason why these securities are often referred to as hybrid securities.
If conversion does not take place, the face value is redeemed as is usual for bonds. At this point, the holder receives the face value and the investment is over. However, a convertible note also has the call option element. A call option gives the holder the right, but not the obligation, to buy a share or shares from the issuer at a fixed price. Obviously, the holder will only do so if it is in the holder’s interest. So, under what circumstances will this occur?
In short, the convertible note holder will exercise the call option if the price to be paid for each share is less than the market price of the shares. When the convertible note reaches maturity, the holder gives the issuer notice of conversion. The note is then notionally redeemed and the proceeds are then used to pay the issuer for the new share.