Convertible Debt Rises, Sustainability Falls

Boosted by a combination of a stronger-than-expected US economy and the prospect that monetary conditions will improve in the second half of the year, US companies with investment-grade ratings have raised more than a whopping $265 billion this year as of March 12, according to data from Dealogic. “There’s ample appetite among investors to reallocate to fixed income given today’s higher rates,” says Mike Zaccardi, CEO of Zaccardi, LLC. 

But one corner of the market isn’t riding the boom: Sustainability-linked bonds (SLBs). According to Dealogic, there were only three transactions of such kind in the US year-to-date as of mid-March. Globally, the trend is similar, with SLBs in 2023 down 51% YoY. This contrasts with corporate green bonds, which had surged by 48% this year as of March 12, reaching a total of $52.6 billion.

Syed Hasan Jafar, associate dean of graduate programs at Woxsen University in Hyderabad, blames the subpar performance of SLBs on their complex nature and the lack of standardization as to key performance indicators. “Due to uncertainties regarding the legitimacy and significance of these instruments, many investors are still reluctant to adopt SLBs fully,” he says. Some hope that the SEC’s new climate disclosure guidelines will lead to a more mature market for sustainability-linked products. (related story in Trends p. 80)

Meanwhile, in the US, at least, among the corporate bond market’s many flourishing corners, convertible debt is getting attention, particularly for high-flying mid-cap tech companies like Super Micro Computer, MicroStrategy, and Lyft. “The favorable landscape allows firms to borrow under more-advantageous conditions, securing lower spreads above risk-free rates, indicative of cheaper capital compared to periods of market stress,” explains Gaël Fichan, head of fixed income at Swiss private bank Syz Group.

Hasan Jafar warns these issuances carry significant risk: “Convertible debt can lead to dilution of ownership if the company’s stock price rises significantly.” Syz’s Fichan agrees: “Those [convertible bonds] issued by smaller tech companies could face increased vulnerability due to potential tight funding scenarios or abrupt market corrections.”