Hybrid Vigor: Volume 1 Issue 21 "Hurts So Good"

Dear Friends,

It’s been ugly out there. And not just for Hillside’s Ugly 20.

Frankly, even though there’s been plenty of pain to go around, we think this ugliness comes with an unusually large silver lining. The richness of the convertible market has been no secret. With a substantial amount of overvaluation wrung out of the market, we think things can proceed on a much healthier basis from here. There is still plenty of froth in the market, but it’s been reduced significantly. Hopefully the positive new issuance trend will continue but at levels and sizes the market can handle more comfortably.

As a self-appointed spokesman for our asset class, I felt—especially based on inquiries and comments I was getting from industry contacts last week—that a worthwhile project would be to examine recent flows and put some thought into what they meant. We all know that convertibles make a lot of sense for traditional fixed-income investors who are looking to minimize their duration and add some potential return to their low-yielding portfolios. What we don’t know is how those investors will react when, new to converts, they start seeing the kinds of quick losses you simply don’t get with straight bonds.

To get a feel for this, we reviewed most of the major convertible mutual funds, analyzing their asset changes in 2014. What we came up with may—or may not—be pause for concern.  One clear result is that some rapidly growing funds have substantially better year-to-date results than do their average investors.  What this means for possible future redemptions, of course, is anyone’s guess.

Those of us who’ve been in convertibles for a while have seen investors, with some regularity, put money in and take it out at the worst possible times.  Clearly the first nine months of 2014 were not the best period for putting fresh cash into converts. Will that lead to a redemption wave that gets overextended? We doubt it. But the data inside are worth your review.

We also discuss the recent selloff qualitatively, and add a few thoughts to our recent comments on the GTAT debacle. Finally, we update our summer comments on DryShips and provide a quick note on a small recent issue.

Bill

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