I promised my colleagues that today’s cover would be Trump-free, especially because I am completing a piece for broad circulation about the convertible market in the coming administration. Thoughts of a “no Trump” commentary naturally took me to contract bridge, a great game that I learned as a child and sadly have let slip over the years. But since we often try to compare convertibles to seemingly unrelated worlds, let’s run with it.
Bridge is a four-person card game, two teams, two players per team. Each player sits in a primary direction of the compass: North and South are partners, as are East and West. Each player tries to communicate as much as possible to her or his partner via an auction with a remarkably limited menu of allowable bids. One side reaches a contract stipulating how many four-card “tricks” (one card per player) it thinks it can win. Most contracts involve the designation of one of the four suits as, you know, trump, though contracts can also be played in “no trump”. Each trick (other than the first) begins with a card played by the player who won the preceding trick, and a player holding no cards in the suit led in a trick can win the trick by playing a card from the trump suit. Otherwise the highest card of the suit led wins the trick.
Bridge is all about communication, both in finding the best contract in the auction and in connecting with your partner’s cards in the play of the hand. It also requires a good memory and a talent for logical deduction. How are these things relevant to convertibles?
When it comes to the issuance of new convertibles, communication is everything. Investors tell bankers the kinds of deals they want to buy, often by bidding up existing deals to prices suggestive of a hunger for similar product. Bankers try to convey this information to issuers: the greater the demand suggested by the market, the more aggressively bankers will bid to win deals.
Overbidding, though, is always a danger. It’s no good to bid seven no trump (winning all thirteen tricks: the first six are known as “book”) when your cards and skill are only good enough to make six. Similarly, it’s all well and good to know that there’s plenty of demand for convertible bonds. There certainly is now—we see it in a historically low HOCS of just 65 and change in this week’s top 20. But knowing there’s plenty of demand doesn’t mean you can pay any price and still make money, just as you shouldn’t bid a grand slam when your cards only justify a small slam. Knowing the right bid to make means knowing what your partner holds, even though your partner can only use a few words to tell you. Investors are saying they want convertibles. Dealers just need to bid appropriately.
(This is the cover letter for the subscription-based weekly Hillside's Hybrid Vigor newsletter. For a complete copy, please contact John Anderson at + 1 (646) 712-9289 x 107).