International convertibles are creeping into the portfolios of tax-exempt investors.
Demand from U.S. pension funds and endowments for exposure to international convertibles has been slight, managers said, but a few have been making allowances for their managers to buy non-U.S. paper.
Some pension funds and endowments have been giving their convertibles managers license to invest up to 15% or 20% of their portfolios in international issues.
Money managers and pension fund and endowment executives said there is noticeable reluctance by institutions to invest. The reason, some suggested, is pension fund executives and consultants haven't yet found a place for convertibles in their asset mixes.
Not all pension funds, however, have shied from international convertibles. The Genessee County Employees Retirement System, Flint, Mich., has a $22.5 million convertibles portfolio with a 20% exposure to the international markets.
The fund has had "a good, safe return with minimal amount of risk," said Warren Vyvyan, retirement office supervisor with the $450 million fund. Its manager, Calamos Asset Management, can invest internationally only in investment-grade issues, he said.
Despite being issued at lower coupons than corporate bonds, convertibles offer investors advantage, some argue. Ideally, when stock markets rally, the convertible mimics its stock. When equity markets fall, it acts like a bond.
And the international market is heating up. A deluge of convertibles has been issued in Europe this year, outpacing the U.S. market. Close to E21 billion ($20 billion) was issued through Aug. 24. In the United States, $15.4 billion had been issued in the first half of the year.
"European product is becoming much more looked at by U.S. investors. They just can't avoid it because it's become so big," said Donough McDonough, Lehman Brothers' head of global convertibles in New York.
Europe's conversion to a single currency has sparked much of the market, sources said. So have corporate restructurings and mergers and acquisitions across Europe.
Managers clearly are bullish about the developments overseas.
"The European and international market looks like the domestic market in the '80s," said John Calamos, chief executive officer for his Naperville, Ill.-based firm. The manager runs $2 billion in assets for pension funds, endowments and other institutional investors. About 15% of that comes from non-U.S. clients.
The firm hasn't seen a single search in international convertibles, but has seen some convertibles searches that include international this year, he said.
Other managers also are tailoring portfolios to include international convertibles.
"We have individually managed portfolios with a range of constraints and specifications," said Ravi Malik, a portfolio manager and senior vice president with Froley Revy Investment Co. Inc., Los Angeles.
Froley Revy has no U.S. pension fund clients with exposure to international convertibles. Seven endowment clients, however, have given the firm license to invest up to 15% of their portfolios in non-U.S. issues.
The median convertibles portfolio of Froley Revy's endowment clients is $10 million, he said.
And the deluge in Europe has cheapened the market, some said.
"We view the current situation in the European market as an opportunity to find value and participate in an expected rebound," said Sandra Durn, a portfolio manager with Pacific Investment Management Co. in Newport Beach, Calif. "The good news is that European convertibles held up well relative to their underlying stock prices over the past months." PIMCO has $300 million in convertibles, with $100 million invested internationally. Of that, about 80% is in Europe and 20% in Asia.
Some investors are adding to their convertibles mandates, she said. Clients have expanded mandates to allow the use of convertibles in their separate accounts at an average of 5%, including international convertibles.