The Investment Association’s (IA) classification of convertible bond funds as equity vehicles has been criticised by wealth managers with unitised portfolios, who claim the rules force them to hold unattractive fixed income instruments.
Under existing requirements, funds of funds in the IA’s three Mixed Investment sectors, which have preset allocation ranges for particular asset classes, must count convertible bond fund holdings as equity exposure.
The asset class, which saw prices drop at the start of 2016 as a result of a panic over contingent convertibles (cocos), has lagged high-yield debt performance since then, increasing its attraction to some wealth managers. Investment Adviser reported last week that yields on European junk bonds had fallen below those offered by equities for the first time on record.
In this context current rules are restrictive, according to Daniel Lockyer, fund management chief investment officer at Hawksmoor.
He said: “I’m certain we would have more [convertible bond funds] today if they could replace our high-yield exposure in our Vanbrugh portfolio, which is in the 20-60 per cent Shares sector and needs 30 per cent or more of fixed income and cash and is right on the limit now. We don’t think conventional bonds generally are attractive at the moment.”
Neil Shillito, co-manager of the Downing Diversified Global Managers vehicle, said a reclassification would be sensible.
He said: “Ultimately, the name tells you all you need to know: they are convertible bonds. Admittedly they can be converted to equity at a pre-determined date, but that is a right, not an obligation. They are fixed interest instruments and should be classed as such.”
Momentum chief investment officer Michael Allen added: “We see them as more of a hybrid instrument. I would certainly support reclassifying them.”
Providers said they had not seen major demand for classification changes, but acknowledged confusion might exist.
Paul Boughton, head of sales and marketing at Mirabaud, which runs a €285m (£250m) Convertibles fund, said: “Most multi-asset clients put it into a specialist box – they don’t class it as equity or bonds. But it’s always fixed income analysts that follow [the space].”
Iain Evans, global head of distribution at Polar Capital, manager of the $600m (£465m) Global Convertible fund, said there was “no definitive answer” to classification.
Of the seven convertibles funds housed within IA sectors, six gauge their performance against that of a dedicated convertible bond index – rather than a broader bond or equity market – while one has no specified benchmark.
David Thornton, a multi-asset manager at Premier, said his team generally treated convertible bond fund holdings as “lower risk equity”, but noted the behaviour of such instruments may become more volatile as firms’ underlying share prices rise.
The IA said in a statement: “The Investment Association continually reviews the classification of funds within its sectors... in 2011, the classification of convertible bonds as equities was agreed following extensive consultation.”