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China Fund News reporter Liu Ming and Wu Jun

Recently, Guanghui Convertible Bond became the first high-rated convertible bond to reach the "face value delisting" standard, which attracted market attention. In the past two months, the prices of some relatively weak convertible bonds have fluctuated violently, and a rare situation in history has occurred in which 100 convertible bonds fell below the face value of 100 yuan. What happened to the 800 billion yuan convertible bond market, and where will the market go in the future?

China Fund News interviewed six private equity institutions that are actively investing in convertible bonds. They said that the current sharp market fluctuations are related to the excessive amplification of investor sentiment. Judging from the current prices and valuations of the convertible bond market, a golden pit has been created and it is in the over-allocation range, and they will increase investment and allocation.

Pan Huanhuan, founder and general manager of Hengli Fund:This round of decline has seen a rare golden pit in history, with many stocks being mistakenly killed. We have begun to gradually increase our holdings of high-yield convertible bonds and diversify across industries and targets. The current situation where a large number of convertible bonds are below par is only a temporary market feature and will not become the norm.

He Weijian, Director of Investment Research Department of Infore Capital and Convertible Bond Fund Manager:At present, convertible bonds have entered the overweight range, and the convertible bond investment will be increased. After doing a good job of risk clearance, more low-priced convertible bonds will be deployed to diversify the investment portfolio. Against the background of severe asset shortage on the fixed income side this year, the pure bond substitution of convertible bonds is a rare asset allocation opportunity for stable funds.

Li Xixi, partner of Newda Investment:The current absolute price of convertible bonds is low, and a large number of convertible bonds have been mistakenly sold due to credit risk concerns. A large number of downward revisions provide support for convertible bond valuations and provide a source of excess returns. Investors should also be wary of the risks of delisting and default. Convertible bonds do not have an advantage in the order of debt repayment. Convertible bonds are unsecured bonds and have a lower repayment order than secured bonds.

Hesheng Assets:It is normal that the "bond bottom" of some convertible bonds has been broken, because the market generally ignored the credit risk of convertible bonds before, and many institutions may not have anticipated the possibility of convertible bond defaults or large-scale defaults.

Asset management:Equity-oriented and balanced strategies will focus on the elasticity brought by the underlying stocks, focusing on the main lines of recovery and technology, such as convertible bonds with bottom-up recovery and supported performance. Conservative strategies focus on low-volatility dividend targets, including stocks with high dividends, convertible bonds with low absolute prices, and high yields to maturity.

Aifang Assets:This time, the retracement of a large number of convertible bonds exceeded that of the underlying stocks. Historically, similar market conditions have occurred at the end of November 2018, the end of January 2021, and the end of December 2022. Judging from the results, they are all relatively obvious bottom positions. It is a better strategy to insist on holding or buying at the bottom.

Here are the top 10 takeaways from the interview:

1. Credit concerns and other factors intertwined, the convertible bond market fell below par value on a large scale

Recently, about 100 convertible bonds in the entire market have fallen below their face value. The private equity firms interviewed believe that the interweaving of multiple factors has caused the convertible bond market to experience drastic fluctuations.

Pan Huanhuan analyzed that, first, small and medium-sized market capitalization stocks fell, and the corresponding convertible bonds also fell synchronously; second, the new "Nine National Regulations" were introduced, and the market gradually understood the delisting indicators such as financial, regulatory, and par value. As some companies had their ratings downgraded, were questioned, filed, and delisted at par value, many low-rated companies were repriced; third, institutional investors accounted for a high proportion of the convertible bond market. When related risks emerged, various risk control departments raised the investment threshold to avoid possible risks, which led to the selling of convertible bonds by some institutional groups, causing a certain stampede.

He Weijian also said that the sharp drop was caused by the resonance of multiple factors: first, the fundamentals of some companies are weak and their debt repayment ability has declined; second, the performance of small and medium-sized market capitalization stocks has been weak this year; third, from May to July, many convertible bonds were sent inquiry letters or had their ratings downgraded, resulting in institutional investors' passive selling and a decline in market risk appetite.

Li Qianqian said that the main reasons for the fluctuations in low-priced convertible bonds since June are: first, the delisting storm, especially the increased possibility of delisting of bonds with a face value of 1 yuan; second, credit concerns. Some small and micro-cap stocks facing delisting risks have also triggered investors' concerns about the credit default risk of convertible bonds, resulting in rating downgrades and institutional withdrawals in June.

Hesheng Asset Management believes that the sharp fluctuations in the convertible bond market are mainly affected by emotions, and the fluctuations caused by fundamental changes will not be reflected so quickly. "We also speculate that some funds with a relatively large proportion of convertible bonds in their assets have been passively sold due to redemption after a decline in net value or psychological fluctuations of the client."

Licheng Asset Management said that the reasons for the recent decline in convertible bonds include credit risk and the switching of equity market styles. Since the beginning of this year, the credit ratings of many convertible bonds have been downgraded, causing market concerns about the solvency of the companies; the decline of the underlying stocks is also the reason for the decline in convertible bonds. This year, small-cap stocks have performed weaker than large-cap stocks. The liquidity risk caused by the decline in convertible bonds has led to more violent fluctuations.

2. High-rated convertible bonds trigger delisting, so be cautious about low-price targets

Recently, relatively high-rated convertible bonds and relatively large-market-cap stocks have triggered delisting. Private equity firms believe that investors should remain vigilant about low-price targets and pay attention to fundamental research on the underlying stocks.

Pan Huanhuan said that historically, there were relatively few cases of convertible bonds being delisted, and most of them were ST stocks that were delisted, and the remaining convertible bonds at the time of delisting were not large. Recently, due to the delisting of Guanghui Auto’s par value, the Guanghui convertible bonds with an AA rating and a scale of 2.88 billion yuan were delisted, which had a relatively large impact on the market. Investors not only find it difficult to rely on external ratings, but also remain cautious about convertible bonds with low stock prices.

Licheng Asset Management said that for convertible bonds with the risk of forced delisting or weak fundamentals, even if the price is low, we should remain sober and cautious. For convertible bonds with strong debt characteristics, credit risk and liquidity risk need to be taken seriously. The essence of debt protection is that the company's fundamentals are supported. Therefore, in the process of selecting convertible bonds, research and judgment on the company's fundamentals should be put first.

3. Delisting has a significant impact on the value of converted shares and pure bonds, and investors should be alert to related risks

How much impact does delisting have on convertible bonds? Li Qianqian said that according to regulations, delisted convertible bonds can be traded on the National Equities Exchange and Quotations for Small and Medium Enterprises. Although in theory delisted convertible bonds still have basic functions such as conversion, redemption, resale, interest payment and repayment of principal and interest, they are actually subject to greater restrictions. From a pure debt perspective, because convertible bonds are classified as unsecured bonds in terms of debt classification, the order of repayment is lower than that of secured bonds but higher than that of equity. "Therefore, we believe that delisting has a huge impact on conversion and pure bond value, and investors should be wary of the risks involved."

Pan Huanhuan bluntly stated that delisting has a great impact on the investment value of convertible bonds, and the direct impact is reflected in the liquidity and liquidity discount of the underlying stock and convertible bonds. After delisting, the trading activity of the third board will decrease, so the value of the underlying stock and convertible bonds will drop significantly; in addition, under the same conditions, the credit rating and financing ability after delisting will be reduced, which will increase the risk of default and indirectly reduce the value of pure bonds.

He Weijian also believes that although delisting does not mean default, as long as the company's credit is safe enough, in theory, delisting will not affect the pure bond value and conversion value of the convertible bonds. But in fact, generally delisted companies have higher credit risks; at the same time, after delisting, the company's financing ability will be further weakened, which will lead to an increase in credit risk. After delisting from the main board to the third board, liquidity will be weakened and the conversion value will also be reduced.

4. Eliminate the targets with default risks through “demining” and increase the allocation of the wrongly killed varieties

The reporter learned that many private equity firms have avoided risky targets through "mine clearing", while diversifying their holdings and increasing their allocations to stocks that have been mistakenly killed.

Li Xixi said that since 2019, Newda has been very vigilant about the risk of delisting of listed companies, insisted on "clearing mines" and avoided risky targets.

Pan Huanhuan said that Hengli Fund uses a compound strategy to respond to market changes in convertible bond investment, including double-low, high volatility, value-driven, cycle reversal, debt protection, clause game, arbitrage and other strategies. The company rarely holds convertible bonds with fundamental flaws and credit risks. However, in this round of decline, due to the stampede of liquidity, many varieties were mistakenly killed, and it also began to gradually increase its holdings of high-yield convertible bonds.

He Weijian said that Yingfeng Capital adopts a convertible bond long strategy that combines "quantitative + subjective". Most of the targets are opened only when the yield to maturity is positive, and the style is relatively conservative.

Hesheng Assets admits that the sharp decline in recent months will bring some opportunities. The convertible bonds held by the company have made a positive contribution to the products as a whole, and the positions are characterized by low prices and dispersion. At the same time, through communication, the client is made aware of the investment risks in the convertible bond market and ensures that such risks are within the acceptable range of the other party, so that the liability side will be relatively stable and the investment side will be more relaxed.

5. Currently, it is a rare golden opportunity in history, and the allocation of convertible bonds will be increased

Regarding the current convertible bond market, many private equity firms believe that it is currently in an over-allocated range and has already hit a golden pit. Many private equity firms have expressed that they will actively pay attention and increase investment and allocation in convertible bonds.

"This time, the large-scale convertible bonds have retreated sharply. Historically, similar market conditions have occurred at the end of November 2018, the end of January 2021, and the end of December 2022. Judging from the results, they are all relatively obvious bottom positions. It is a better strategy to insist on holding or buying at the bottom." Aifang Asset said.

Pan Huanhuan said that the convertible bond market has fluctuated violently in recent months. After several rounds of adjustments, the valuation center has been objectively lowered, and a rare golden pit has appeared in history. Investment should be made when no one is interested. Hengli Fund will also increase the allocation and investment of convertible bonds.

Pan Huanhuan believes that there are three reasons for being optimistic about the convertible bond market: First, the recent decline in convertible bonds has created a golden pit, and the overall annualized yield of convertible bonds has increased. As of July 19, 244 of the 528 convertible bonds had an annualized yield of more than 2%, 174 exceeded 3%, and 134 exceeded 4%, which is very rare in history. Second, convertible bonds have been frequently revised downward, and the conversion value has increased in leaps and bounds. This year, it has been revised downward 112 times, and the first half of the year has exceeded the full-year data of all historical years. Third, the stock market is at a relatively low level, and the room for the underlying stock to rise is greater than the room for decline. The rise in stocks will significantly drive up the price of the corresponding convertible bonds.

He Weijian believes that convertible bonds have entered the over-allocation zone after the absolute price median of the entire market fell below 110 yuan. As of July 18, the index was 109.8 yuan, entering the over-allocation zone judged by Yingfeng Capital, so convertible bond investment will continue to increase in the future. Against the backdrop of a severe asset shortage on the fixed income side this year, convertible bonds' pure bond substitution is a rare asset allocation opportunity for stable funds.

He Weijian said that after this round of decline, the overall performance of low-priced convertible bonds is that the opportunities outweigh the risks. From a quantitative point of view, among the 100 convertible bonds that fell below par, about 40% are prohibited from investment on the blacklist of Yingfeng Capital, and are also considered to have real default risks. Most of the other 60% do have some credit defects, but as a whole, the risk compensation is sufficient.

Li Qianqian believes that the current absolute price of convertible bonds is low, and a large number of convertible bonds have been mistakenly sold due to credit risk concerns. A large number of downward revisions provide support for convertible bond valuations and a source of excess returns. The market provides a good opportunity to buy at the bottom on the left side.

Hesheng Asset Management said that the current convertible bond market has a relatively high cost-performance ratio. Licheng Asset Management also said that it will maintain a relatively positive focus on the convertible bond market and increase its allocation of convertible bonds.

6. Debt-to-convertible bonds are at the bottom of historical valuations, and the allocation value is optimistic

The reporter learned that after the big drop, many private equity firms were optimistic about the allocation value of debt-type convertible bonds and increased their holdings, and were also optimistic about the flexibility of equity-type convertible bonds. At the same time, private equity firms deployed low-priced convertible bonds in batches.

Pan Huanhuan said that we should pay attention to indicators such as the competitiveness of the main business, financial authenticity, debt ratio, cash flow, realizable assets, stock price, pledge ratio of major shareholders, convertible bonds to market value ratio, etc., and rely on internal ratings to exclude bonds with credit risks. Currently, after the valuation center of the convertible bond market has moved downward, the opportunities for equity and debt convertible bonds have increased.

He Weijian said that currently both debt-based and equity-based convertible bonds are deployed; after clearing risks, more low-priced convertible bonds are deployed to diversify portfolio investments. Debt-based convertible bonds are generally at the bottom of historical valuations, and their certainty of locking in absolute returns is also stronger. Low-priced convertible bonds also have strong downward revisions, and this year's downward revision proposals have reached more than 110, and the profitability of the downward revision strategy has been significantly improved. As a large number of convertible bonds enter the repurchase period in the future, Yingfeng Capital believes that the downward revision intensity will remain high.

Licheng Asset Management said that equity-oriented and balanced strategies will focus on the elasticity brought by the underlying stocks, and focus more on the main lines of recovery and technology, such as convertible bonds with bottom-up recovery in industry prosperity and supported performance. The conservative strategy focuses on low-volatility dividend targets, including stocks with high dividends, low absolute convertible bonds, and high yields to maturity.

7. With moderate volatility and good liquidity, convertible bond assets are worth paying attention to in the long term

Convertible bonds have experienced such dramatic fluctuations recently, especially the "debt bottom" of a large number of convertible bonds with a face value of 100 yuan has been broken. As a type of investment product, what is the future prospect? The private equity interviewed said that convertible bonds will still be a type of asset worthy of attention in the long run, and many convertible bonds still have the characteristic of "debt having a bottom".

Regarding the "debt bottom" being broken, Hesheng Asset Management said that it was normal for the "debt bottom" of some convertible bonds to be broken, because the market generally ignored the credit risks of convertible bonds before, and many institutions may not have anticipated the possibility of convertible bond defaults or large-scale defaults.

Regarding the characteristics of convertible bonds, Pan Huanhuan said that compared with stocks and bonds, convertible bonds have moderate volatility and good liquidity, and are worthy of long-term attention. The convertible bond market has recently seen new changes, and will be more differentiated in the future, with both dangers and opportunities. Investors should conduct in-depth research on various factors such as bond issuance terms, changes in regulatory policies, convertible bond market characteristics, the mutual impact of stocks and bonds, corporate credit assessments, and changes in investor structure.

He Weijian also believes that convertible bonds are still a good asset management track. He Weijian said that conservatively speaking, about 70% of convertible bonds still have the characteristics of "having a bottom"; 10% of convertible bonds that are on the "blacklist" of Yingfeng Capital Investment may have lost their bottom protection; the other 20% of convertible bonds are on the "gray list" and still have a bottom, but the bottom center may be lower than the face value.

Regarding the future space of the convertible bond market, Licheng Asset Management said that convertible bonds have relatively favorable institutional arrangements for investors, good investment experience, and are relatively popular. They are also conducive to the refinancing of issuers. In the long run, it is believed that the convertible bond market will continue to expand and provide investors with sufficient breadth and depth.

8. Market sentiment is over-amplified, and a large number of convertible bonds below par value will not be the norm

Among the more than 500 convertible bonds in the current market, about 100 convertible bonds are priced below the face value of 100 yuan, accounting for nearly 20%. Whether this situation of a large number of convertible bonds priced below face value will become the norm in the future has attracted market attention. The private equity firms interviewed believe that market sentiment has been overly exaggerated, and a large number of convertible bonds priced below face value will not be the norm.

Pan Huanhuan said that the characteristics of convertible bonds have not changed. Based on the current valuation, he is more optimistic about the prospects of the convertible bond market, because after filtering out short-term fluctuations, there is more room for appreciation. Fear has been over-amplified by the market, and a large number of convertible bonds below par are only a temporary market feature and will not become the norm.

Aifang Asset Management believes that delisting is the biggest risk point in convertible bond investment. We will try our best to avoid it and make pricing more reasonable through models and blacklist settings. However, the current large-scale drop below the par value is still caused by market sentiment. In the future, we will continue to insist on convertible bond investment and continue to conduct in-depth research using quantitative methods.

IX. According to current estimates, the proportion of delisting risk targets is relatively low

The delisting of convertible bonds is of great concern to the market and is also an important reason for the large-scale decline in convertible bonds. The private equity firms interviewed believe that, at present, the proportion of convertible bonds delisting is expected to be low.

He Weijian said that according to the latest delisting standards: from the perspective of "face value delisting", the closing price will be lower than 1 yuan face value for 20 consecutive trading days. Currently, there are 11 convertible bonds with a share price lower than 2 yuan, accounting for about 2%; from the perspective of "market value delisting", the main board is less than 500 million yuan, and the science and technology innovation board and the Growth Enterprise Market are less than 300 million yuan. Currently, there are 2 convertible bonds with a main board of less than 1 billion yuan and a science and technology innovation board and the Growth Enterprise Market of less than 600 million yuan, accounting for 0.4%; in terms of "financial delisting", there are 3 convertible bonds that meet the standards, accounting for 0.6%. According to calculations, the total proportion of targets with delisting risks is relatively low. Pan Huanhuan also judged that the delisting ratio of convertible bonds is relatively low.

10. To deal with the risks of delisting and default, it is necessary to strengthen the research on companies and delisting rules and set up an investment "blacklist"

Regarding how to eliminate delisting risk and credit risk in investment and how to avoid possible risks in the convertible bond market, many private equity firms interviewed said that the key is to strengthen research on listed companies, identify the qualifications and risks of companies, study delisting rules, and set up an investment "blacklist."

Licheng Asset Management stated that for companies with large industry space, good competitive landscape and continuously improving moat advantages, their stock prices have long-term upward momentum, can also provide support for convertible bonds, and are less likely to experience delisting and credit risks.

Pan Huanhuan said that the main measure to avoid convertible bond market risks is to strengthen company research, identify targets with serious mismatches between true value and price through research, and at the same time diversify across industries and targets to avoid holding too high a proportion of highly correlated products, and deal with risks through diversification.

Pan Huanhuan believes that investors need to carefully study the delisting rules and analyze whether the company has any signs of financial, regulatory, transactional, or major illegal delisting behavior under the existing rules. Corporate credit risks often come from high debt, bad receivables, mismatch between financing and fund use periods, lack of business hematopoietic capacity, rapid expansion, lack of cash cows in the industry portfolio, and bank loan withdrawal.

He Weijian said that Yingfeng Capital uses a combination of blacklists and gray lists, combined with quantitative models and fundamental analysis, to clear convertible bonds with poor qualifications. Since the number of mines cleared is large enough, delisting and credit risks are avoided to a large extent in actual investment.

He Weijian believes that this round of credit shocks on convertible bonds should not be simply understood as a "black swan" event, and the overall risk can be identified and prevented in advance.

He Weijian said that after the first delisting case occurred in the convertible bond market last year, Yingfeng Capital further strengthened risk control in advance on the basis of a perfect ex ante risk control system and refined the screening criteria for the blacklist and gray list.

First, after the mandatory elimination of the last 10% of the bonds with the highest credit risk, they will be put on the “blacklist” for investment prohibition. Even if the annual delisting ratio is raised to 3%, the 10% blacklist is sufficient to cover its risks. Second, a “gray list” was further established, which is 20% of the companies selected from the blacklist. The upper limit of the position of a single bond was set at 0.5%, so as to deal with risks with a fully diversified investment approach and achieve an effective balance between drawdown control and profit acquisition.

Li Qianqian said that by studying the issuer's revenue and profit indicators, major illegal indicators, regulatory indicators, transaction indicators, dividends, financial fraud and room for downward revision of conversion prices, the possibility of delisting of listed companies is analyzed, and at the same time, public opinion is monitored and mines are cleared to eliminate targets with potential default risks.

Editor: Captain

Review: Muyu

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