A Three-Source Multi-Factor Framework for Convertible Bond Selection

Summary

This research note organizes convertible-bond factors into three groups: factors from the underlying stock, factors describing the bond-stock relationship, and the convertible bond’s own price and volume behavior. It reports that earnings yield and northbound capital flows were useful underlying-stock signals, with negative and positive relationships, respectively, to subsequent bond returns. Bond-stock measures, including conversion premium and deviations in bond and stock movements, are described as especially significant and stable.

The authors combine nine factors after outlier treatment and standardization, then form an equal-weight portfolio of the 20 highest-scoring bonds each period. In the reported historical test from January 2018 through June 2021, the combined factor had a mean IC of 9.35% and an IC information ratio of 1.89; the portfolio returned 34.6% annualized with 20.8% annualized volatility and 26.1% annualized excess return over the China Securities Convertible Bond Index. These are backtest results, and the note warns that future market conditions may differ materially.

Key ideas

• Convertible bond factors can be grouped into underlying-stock signals, bond-stock relationship signals, and bond-level price and volume signals.
• The note identifies earnings yield and northbound capital flows as useful underlying-stock measures, with opposite return associations.
• Conversion premium and other bond-stock divergences are presented as central signals because they capture relative expectations.
• The reported portfolio equally weights nine processed factors and holds the 20 highest-scoring bonds each period.
• The performance figures come from a historical test and may not persist under changed market conditions.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.