Convertibles are driving until the wheels fall off
The promise of equity riches tomorrow is tempting investors to offer cheap credit today. In July, companies worldwide issued $11.4 billion of bonds that can convert into shares, the busiest such summer stretch since 2007, according to Bank of America 
BAC data. With stock prices rising to record levels, lenders have been swept up in the momentum, marking the kind of risk-on attitude that makes low-interest-rate convertibles appealing. History suggests that such periods do not end well.
Two features stand out. First, plentiful supply: the year-to-July tally of issuance stands at $82 billion, up 18% from the same period in 2024, says BofA. Second, generous terms: companies from Chinese marketplace Alibaba 
BABA to cloud security provider Zscaler 
ZS have sold bonds bearing no interest. Some of them only convert if the underlying stock price climbs by as much as 50%.
Investors accepting such toppy terms can at least point to decent performance. Globally, convertibles have returned about 12% on a U.S. dollar basis through July, according to NYSE operator Intercontinental Exchange, beating the MSCI World Equity Index, let alone high-yield or investment-grade credit. After all, as equity prices rise, so does the value of the option to swap debt into shares.
Adding to the exuberance is the recent pairing of bonds and cryptocurrencies. Incredibly, convertibles issued by companies that hoard bitcoin and its ilk, like Michael Saylor-led darling Strategy 
MSTR, now make up over 10% of the U.S. market, up from less than 2% in 2022, BofA reckons. The average coupon in the United States: around 1%. Yet despite being tied to businesses that usually produce little to no cashflow, hedge fund buyers have plenty of reason to pile in. Using a popular arbitrage strategy, they profit not just from a rising share price, but a wildly erratic one: the higher the volatility, the better.
This is a substantial slice of the market, and its economics depend on volatility not vanishing altogether. If bitcoin's price swings narrow, a related convertible's equity option loses value, leaving investors with little more than a thin coupon. In the worst case, a breakdown in the debt-raising and coin-hoarding apparatus would leave issuers with limited cash flow edging closer to default.
Sentiment is turning as terms stay sweet. Fund managers surveyed by BofA believe that convertibles have little remaining fundamental upside and are accordingly holding more cash. Such prophecies usually come true, presaging weaker equity performance and consequently thinner returns for bondholders. When the bill comes due, borrowers looking to refinance may find themselves in a new, meaner world.
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CONTEXT NEWS
About $11.4 billion of convertible bonds were issued globally in July, according to Bank of America, the highest volume for the month dating back to 2007 and over two-and-a-half times its historical average.
