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SUCCESS FACTORS RMF INVESTMENT GROUP

The following factors are critical for the success of a Convertible Bond investor: RMF Investment Group is the leading provider of Alternative Investment
Solutions, specialising in Hedge Funds, Leveraged Finance, Private Equity
 Asset allocation skills because of the wide divergence between returns of sectors and and Convertible Bonds. Focused on the institutional market, RMF’s
countries over certain periods target clients include pension funds, insurance companies, banks, large
corporations and distribution channels. RMF’s headquarters is in Switzer-
 State-of-the-art models to keep up with the ever increasing sophistication of the other land, however the Company also has physical presence in the
market participants major financial centres.

 Credit skills to assess the corporate bond-type credit risk RMF commenced activities as an operative Hedge Fund Manager in 1992
with an exclusive mandate for one of the world’s most prestigious Market
 Relationships to investment banks for access to new issues and stock borrowing Neutral Hedge Funds. Over the years, RMF has continued to focus on
(CB arbitrage) servicing investors by providing comprehensive products and solutions
and is regarded as an innovator in the Alternative Asset Management
 Market timing skills to protect the capital in extended phases of equity market weakness Industry.

 Risk management skills to avoid unwanted exposure to all types of risk including interest In May 2002, RMF was acquired by the Man Group creating the largest
rate and currency risk independent Alternative Investment Manager in the market, with approxi-
mately USD 20 billion under management (excluding Real Estate and
 Proprietary trading experience and mentality to take advantage of the relative value Private Equity). As of 30 June 2002 RMF had funds under management
characteristics of the instrument of approximately USD 9.5 billion.

RMF is a process driven organisation, and one of the few organisations


SUMMARY

Convertible Bonds
in the financial services industry to have achieved the ISO 9001: 2000
 In recent years, the Convertibles market has grown at an accelerated pace. More and more Certification for Quality Management Systems.
companies are willing to look at the advantages of financing through Convertibles, and they
find good demand from various investors such as Hedge Funds, Convertible Bond funds or
investment banks. We believe that this trend will continue and that this market will steadily
gain significance in the future

 Convertible Bonds are instruments that are beneficial to both investors and issuers

 Convertible Bonds are an asset class with risk-return characteristics that are superior to CONTACT
those of pure bonds, pure equities, or a blend of bonds and equities For further information please contact:
Client Relations Team
 The successful management of Convertible Bond portfolios depends on various factors such
as asset allocation, security selection and credit skills, state-of-the-art models as well as good RMF Investment Consultants
relationships to investment banks for access to new issues Huobstrasse 16
8808 Pfäffikon/SZ
Switzerland
Phone +41 (0) 55 415 87 10
Fax +41 (0) 55 415 87 94
www.rmf.ch info@rmf.ch

200/Q2_02
An Introduction to the Asset Class
Disclaimer

The content of this documentation is for your information purposes only and constitutes neither a
request, nor an offer, nor a solicitation, nor a recommendation to buy, sell or make an investment in the
described investment instruments or to enter into or conclude other transactions of any kind. The
information provided herein is not intended to provide sufficient basis on which to make an investment
decision. Potential investors should note that alternative investments can involve significant risks and the
value of an investment may go down as well as up. Furthermore, we recommend you consult your bank,
or investment and/or tax adviser. Past performance is never an indication or guarantee of future
performance.
Information contained herein is provided from the RMF database or obtained from sources that RMF
considers to be reliable. However, although RMF has taken professional care in gathering and updating
this material and information, it does not assume any liability in the case of incorrectly reported or
incomplete information, accuracy or correctness. All projections, valuations and statistical analyses are
provided to assist the recipient in understanding the basics of alternative investments. Such projections,
valuations and analyses may be based on subjective assessments and assumptions and may use one
among several alternative methodologies (and other methodologies may produce different results).
Accordingly, such projections, valuations and statistical analyses should not be viewed as facts and
should not be relied upon as a prediction of future events.
The information in this documentation is not intended for persons and organizations subject to U.S.
federal, state or local law or to the law of any foreign jurisdiction prohibiting the use or attention of this
information whether on the basis of domicile, nationality or for other reasons. This document and all
information contained within is proprietary information of RMF and its affiliates and may not be
reproduced or otherwise disseminated in whole or in part without prior written consent from RMF. A member of the Man Group
DESCRIPTION CHARACTERISTICS (CONT.) CHARACTERISTICS (CONT.)
Convertible Bonds (CBs) are fixed income instruments that can be converted into a fixed number Investment Categories Yield instrument (out-of-the-money) Efficient Frontier Market data indicate the advantage
18%
of shares of the issuer at the option of the investor. Bonds that are convertible into shares other Convertible Bonds where the underlying share price trades significantly below the conversion of investing in CBs as compared to
than the issuer’s are called exchangeable bonds. price have low equity sensitivity and behave like fixed income securities. The main price fixed income instruments and/or
16%
factors are the interest rate level and the issuer’s credit spread. equities. The chart depicts the 100% CB s,

Annualised Return
Convertibles are fascinating hybrid securities. On the one hand, they have the benefits of debt efficient frontier analysis of investing 0% B o nds
14%
instruments that pay fixed coupons and will be redeemed at maturity at a pre-specified price. On Hybrid instrument (at-the-money) in bonds, equities and Convertible
the other hand, the embedded conversion option provides the investor with a participation in the Convertible Bonds where the underlying share price trades close to the conversion price are Bonds.
12%
upside potential of the underlying equity. considered balanced Convertibles because of their asymmetric payoff profile. They have a 100% E quity ,
medium sensitivity to changes in the underlying equity. These bonds are affected by the The payoff of Convertible Bonds 0% B onds
10%
The conversion right provides the bond holder with a better-of-two-choices option. At maturity, share price performance and volatility movements as well as changes in interest rates and the surpasses the returns achieved by
100% B onds
the Convertible Bonds are worth the higher of (a) their redemption value (the price at which the issuer’s credit profile. The majority of new issues are launched as balanced Convertibles. either pure bonds or equities.
issuer had agreed to buy the bonds back) or (b) the market value of the underlying shares. 8%
Equity alternative (deep-in-the-money) 4% 9% 14% 19%
Annualised Volatility
In other words, a Convertible Bond is a straight bond with an embedded equity call option. Due Convertible Bonds where the underlying share price trades significantly above the conversion
Source: RMF Research
to this call option, the Convertible will participate in any increase of the underlying equity, while price are highly sensitive to changes in the equity, whereas their sensitivity to changes in
the fixed income portion provides capital protection, should the share price fall. interest rates and/or credit spreads is low. These bonds trade at an insignificant premium or
even a small discount to parity. Deep-in-the-money Convertibles will almost certainly be MARKET
converted into the underlying shares at maturity.
CHARACTERISTICS Global Overview The Convertible Bonds market has been growing over the last decade. The data indicate this trend
Payoff profile will continue in the future as both companies and investors become more aware of the benefits of
Price Behaviour of Old New Capital Gain/ Cash- Total Convertible Bonds. The following map depicts the capitalisation of outstanding Convertible
Yield Instrument Hybrid Instrument Equity Alternative Convertibles
Share Price + 25%
Equity
Price
130
Price
162.5
Loss
32.5
flow
1.5
Return
0.3
164 Bonds divided by geographic region (as of December 2001).
162.5

Convertible Bond
Convertible Bond 135 164.0 29.0 4.4 0.2
135
ity
Share Price unchanged
130
Par Equity 130 130.0 0.0 1.5 0.0 120
Europe
Asia (ex Japan)
rice USD 137 bn
rtible P
Convertible Bond 135 135.0 0.0 4.4 0.0
USD 29 bn
Conve
Share Price - 25% 97.5
Equity 130 97.5 -32.5 1.5 -0.2
North America Japan
USD 213 bn USD 91 bn
Bond Floor Convertible Bond 135 120.0 -15.0 4.4 -0.1 Share Price
Premium
Source: RMF Research Source: RMF Research
Convertible price

Global Performance 250


across Asset Classes In the long run, Convertible
200 Bonds can outperform pure
equity and/or pure bond port- The Convertible Bonds Market: USD 470 bn Source: Merrill Lynch

Value Index
Stock price
folios. The studies further show Long-only investors including dedicated CB Funds
150 Market Participants
Source: RMF Research that CBs can replicate the upside The strategy is to generate above average returns via capital gains and interest income while
movements of the share prices enjoying downside protection and lower volatility. Studies show that Convertible Bond portfolios
100 ML-G300 Global Convertibles without the corresponding volatility.
The x-axis displays the underlying share price while the y-axis represents the price of the Con- MSCI Global Equities have outperformed traditional portfolios (50% bonds and 50% equities) on a global basis from
vertible Bond. The dotted diagonal expresses the intrinsic value called parity. Parity represents JPM Global Bonds 1993 to 2000. During this period, they even outperformed pure equity portfolios (CBs returned
the value that the investor would receive upon conversion of the bond. Parity is a lower boun- 50 9.92% p.a., while equities returned 9.07% p.a.) (study by Jefferies).

Dec 94
Jun 95
Dec 95
Jun 96
Dec 96
Jun 97
Dec 97
Jun 98
Dec 98
Jun 99
Dec 99
Jun 00
Dec 00
Jun 01
Dec 01
Jun 02
dary for the price of the Convertible. The yellow line outlines the Convertible‘s fair value. If the Hedge Funds
share price increases, the fair value of the Convertible Bond rises as well. As the share price CB arbitrage is a typical Hedge Fund strategy. The arbitrageur is long a Convertible and short the
increases, the relationship between shares and bonds becomes more direct until the bond price Source: Bloomberg underlying shares according to the CB‘s sensitivity to its underlying (delta), in order to extract the
behaviour and risk profile resemble characteristics of the underlying equity. On the other hand, Convertible‘s ‘cheapness’. If the share price falls, the CB becomes more bond-like and declines
if the share price falls, the bond‘s sensitivity to its underlying share price will decrease and the Correlation Matrix for Intermediat Intermediate- less than the share price, so the trader buys back some shares. Similarly, if the share price rises,
Long-Term Long-Term Mortgage-
bond will not decline to the same extent as the equity. The level which will prevent the Con- Convertibles and other Convertible Large-Cap Small-Cap
Treasury
e-Term Treasury
Corporate
Term
Backed Real Estate the Convertible becomes more equity-like and the trader sells more shares. If it is possible to
Bonds Stocks Stocks Treasury Bills Corporate
vertible from falling further down is shown in the above graph as the bond floor (grey) which is major Asset Classes Bonds Bonds Bonds Bonds Securities
repeat this operation on several occasions, the trader will always be buying low and selling high.
also a lower boundary for the price of the Convertible. Convertible Bonds 1.00
Large-Capitalisation Stocks 0.83 1.00 Equity investors
Small-Capitalisation Stocks 0.80 0.79 1.00
Similarly to straight debt, a Convertible contains the risk of the issuer not being able to repay the Long-Term Treasury Bonds 0.36 0.36 0.12 1.00 As equity investors need or want full upside exposure, their strategy would be to buy deep-in-the-
principal at maturity. This credit risk is expressed in the graph as the steep fall of the bond floor Intermediate-Term Treasury Bonds 0.32 0.28 0.07 0.93 1.00 money CBs. They could often generate an income advantage as the coupon yield is typically
Treasury Bills -0.01 -0.09 0.02 0.00 0.25 1.00
as well as the bond price on the left-hand side. Long-Term Corporate Bonds 0.51 0.51 0.30 0.92 0.91 -0.01 1.00
higher than the dividend yield. Furthermore, they enjoy the benefit of the embedded call option
Intermediate-Term Corporate Bonds 0.52 0.48 0.33 0.90 0.94 0.19 0.97 1.00 on the underlying equity as well as free downside protection, although that may be rather far
The best risk-return profile is located in the red area where the Convertible’s potential upside is Mortgage-Backed Securities 0.42 0.35 0.10 0.87 0.91 0.14 0.95 0.93 1.00 away. The investors could also take advantage of in-the-money CBs trading at a discount to
Real Estate -0.02 -0.23 0.34 0.04 0.09 0.25 0.07 0.16 -0.01 1.00
the greatest while the downside risk is relatively low. RMF focuses on Convertible Bonds priced parity.
in that area. Source: Ibbotson Associates and Goldman Sachs
Fixed income investors
Correlations above are generally calculated using monthly total returns over the period 1973- Fixed income investors tend to buy out-of-the-money CBs that are trading with yields close to
2000. The exceptions are Mortgage Backed Securities, which use the period 1976-2000, and their corporate bond equivalents but contain the added bonus of upside participation of the
Real Estate which uses quarterly returns for the period March 1978-September 2000. underlying share price.
DESCRIPTION CHARACTERISTICS (CONT.) CHARACTERISTICS (CONT.)
Convertible Bonds (CBs) are fixed income instruments that can be converted into a fixed number Investment Categories Yield instrument (out-of-the-money) Efficient Frontier Market data indicate the advantage
18%
of shares of the issuer at the option of the investor. Bonds that are convertible into shares other Convertible Bonds where the underlying share price trades significantly below the conversion of investing in CBs as compared to
than the issuer’s are called exchangeable bonds. price have low equity sensitivity and behave like fixed income securities. The main price fixed income instruments and/or
16%
factors are the interest rate level and the issuer’s credit spread. equities. The chart depicts the 100% CB s,

Annualised Return
Convertibles are fascinating hybrid securities. On the one hand, they have the benefits of debt efficient frontier analysis of investing 0% B o nds
14%
instruments that pay fixed coupons and will be redeemed at maturity at a pre-specified price. On Hybrid instrument (at-the-money) in bonds, equities and Convertible
the other hand, the embedded conversion option provides the investor with a participation in the Convertible Bonds where the underlying share price trades close to the conversion price are Bonds.
12%
upside potential of the underlying equity. considered balanced Convertibles because of their asymmetric payoff profile. They have a 100% E quity ,
medium sensitivity to changes in the underlying equity. These bonds are affected by the The payoff of Convertible Bonds 0% B onds
10%
The conversion right provides the bond holder with a better-of-two-choices option. At maturity, share price performance and volatility movements as well as changes in interest rates and the surpasses the returns achieved by
100% B onds
the Convertible Bonds are worth the higher of (a) their redemption value (the price at which the issuer’s credit profile. The majority of new issues are launched as balanced Convertibles. either pure bonds or equities.
issuer had agreed to buy the bonds back) or (b) the market value of the underlying shares. 8%
Equity alternative (deep-in-the-money) 4% 9% 14% 19%
Annualised Volatility
In other words, a Convertible Bond is a straight bond with an embedded equity call option. Due Convertible Bonds where the underlying share price trades significantly above the conversion
Source: RMF Research
to this call option, the Convertible will participate in any increase of the underlying equity, while price are highly sensitive to changes in the equity, whereas their sensitivity to changes in
the fixed income portion provides capital protection, should the share price fall. interest rates and/or credit spreads is low. These bonds trade at an insignificant premium or
even a small discount to parity. Deep-in-the-money Convertibles will almost certainly be MARKET
converted into the underlying shares at maturity.
CHARACTERISTICS Global Overview The Convertible Bonds market has been growing over the last decade. The data indicate this trend
Payoff profile will continue in the future as both companies and investors become more aware of the benefits of
Price Behaviour of Old New Capital Gain/ Cash- Total Convertible Bonds. The following map depicts the capitalisation of outstanding Convertible
Yield Instrument Hybrid Instrument Equity Alternative Convertibles
Share Price + 25%
Equity
Price
130
Price
162.5
Loss
32.5
flow
1.5
Return
0.3
164 Bonds divided by geographic region (as of December 2001).
162.5

Convertible Bond
Convertible Bond 135 164.0 29.0 4.4 0.2
135
ity
Share Price unchanged
130
Par Equity 130 130.0 0.0 1.5 0.0 120
Europe
Asia (ex Japan)
rice USD 137 bn
rtible P
Convertible Bond 135 135.0 0.0 4.4 0.0
USD 29 bn
Conve
Share Price - 25% 97.5
Equity 130 97.5 -32.5 1.5 -0.2
North America Japan
USD 213 bn USD 91 bn
Bond Floor Convertible Bond 135 120.0 -15.0 4.4 -0.1 Share Price
Premium
Source: RMF Research Source: RMF Research
Convertible price

Global Performance 250


across Asset Classes In the long run, Convertible
200 Bonds can outperform pure
equity and/or pure bond port- The Convertible Bonds Market: USD 470 bn Source: Merrill Lynch

Value Index
Stock price
folios. The studies further show Long-only investors including dedicated CB Funds
150 Market Participants
Source: RMF Research that CBs can replicate the upside The strategy is to generate above average returns via capital gains and interest income while
movements of the share prices enjoying downside protection and lower volatility. Studies show that Convertible Bond portfolios
100 ML-G300 Global Convertibles without the corresponding volatility.
The x-axis displays the underlying share price while the y-axis represents the price of the Con- MSCI Global Equities have outperformed traditional portfolios (50% bonds and 50% equities) on a global basis from
vertible Bond. The dotted diagonal expresses the intrinsic value called parity. Parity represents JPM Global Bonds 1993 to 2000. During this period, they even outperformed pure equity portfolios (CBs returned
the value that the investor would receive upon conversion of the bond. Parity is a lower boun- 50 9.92% p.a., while equities returned 9.07% p.a.) (study by Jefferies).

Dec 94
Jun 95
Dec 95
Jun 96
Dec 96
Jun 97
Dec 97
Jun 98
Dec 98
Jun 99
Dec 99
Jun 00
Dec 00
Jun 01
Dec 01
Jun 02
dary for the price of the Convertible. The yellow line outlines the Convertible‘s fair value. If the Hedge Funds
share price increases, the fair value of the Convertible Bond rises as well. As the share price CB arbitrage is a typical Hedge Fund strategy. The arbitrageur is long a Convertible and short the
increases, the relationship between shares and bonds becomes more direct until the bond price Source: Bloomberg underlying shares according to the CB‘s sensitivity to its underlying (delta), in order to extract the
behaviour and risk profile resemble characteristics of the underlying equity. On the other hand, Convertible‘s ‘cheapness’. If the share price falls, the CB becomes more bond-like and declines
if the share price falls, the bond‘s sensitivity to its underlying share price will decrease and the Correlation Matrix for Intermediat Intermediate- less than the share price, so the trader buys back some shares. Similarly, if the share price rises,
Long-Term Long-Term Mortgage-
bond will not decline to the same extent as the equity. The level which will prevent the Con- Convertibles and other Convertible Large-Cap Small-Cap
Treasury
e-Term Treasury
Corporate
Term
Backed Real Estate the Convertible becomes more equity-like and the trader sells more shares. If it is possible to
Bonds Stocks Stocks Treasury Bills Corporate
vertible from falling further down is shown in the above graph as the bond floor (grey) which is major Asset Classes Bonds Bonds Bonds Bonds Securities
repeat this operation on several occasions, the trader will always be buying low and selling high.
also a lower boundary for the price of the Convertible. Convertible Bonds 1.00
Large-Capitalisation Stocks 0.83 1.00 Equity investors
Small-Capitalisation Stocks 0.80 0.79 1.00
Similarly to straight debt, a Convertible contains the risk of the issuer not being able to repay the Long-Term Treasury Bonds 0.36 0.36 0.12 1.00 As equity investors need or want full upside exposure, their strategy would be to buy deep-in-the-
principal at maturity. This credit risk is expressed in the graph as the steep fall of the bond floor Intermediate-Term Treasury Bonds 0.32 0.28 0.07 0.93 1.00 money CBs. They could often generate an income advantage as the coupon yield is typically
Treasury Bills -0.01 -0.09 0.02 0.00 0.25 1.00
as well as the bond price on the left-hand side. Long-Term Corporate Bonds 0.51 0.51 0.30 0.92 0.91 -0.01 1.00
higher than the dividend yield. Furthermore, they enjoy the benefit of the embedded call option
Intermediate-Term Corporate Bonds 0.52 0.48 0.33 0.90 0.94 0.19 0.97 1.00 on the underlying equity as well as free downside protection, although that may be rather far
The best risk-return profile is located in the red area where the Convertible’s potential upside is Mortgage-Backed Securities 0.42 0.35 0.10 0.87 0.91 0.14 0.95 0.93 1.00 away. The investors could also take advantage of in-the-money CBs trading at a discount to
Real Estate -0.02 -0.23 0.34 0.04 0.09 0.25 0.07 0.16 -0.01 1.00
the greatest while the downside risk is relatively low. RMF focuses on Convertible Bonds priced parity.
in that area. Source: Ibbotson Associates and Goldman Sachs
Fixed income investors
Correlations above are generally calculated using monthly total returns over the period 1973- Fixed income investors tend to buy out-of-the-money CBs that are trading with yields close to
2000. The exceptions are Mortgage Backed Securities, which use the period 1976-2000, and their corporate bond equivalents but contain the added bonus of upside participation of the
Real Estate which uses quarterly returns for the period March 1978-September 2000. underlying share price.
DESCRIPTION CHARACTERISTICS (CONT.) CHARACTERISTICS (CONT.)
Convertible Bonds (CBs) are fixed income instruments that can be converted into a fixed number Investment Categories Yield instrument (out-of-the-money) Efficient Frontier Market data indicate the advantage
18%
of shares of the issuer at the option of the investor. Bonds that are convertible into shares other Convertible Bonds where the underlying share price trades significantly below the conversion of investing in CBs as compared to
than the issuer’s are called exchangeable bonds. price have low equity sensitivity and behave like fixed income securities. The main price fixed income instruments and/or
16%
factors are the interest rate level and the issuer’s credit spread. equities. The chart depicts the 100% CB s,

Annualised Return
Convertibles are fascinating hybrid securities. On the one hand, they have the benefits of debt efficient frontier analysis of investing 0% B o nds
14%
instruments that pay fixed coupons and will be redeemed at maturity at a pre-specified price. On Hybrid instrument (at-the-money) in bonds, equities and Convertible
the other hand, the embedded conversion option provides the investor with a participation in the Convertible Bonds where the underlying share price trades close to the conversion price are Bonds.
12%
upside potential of the underlying equity. considered balanced Convertibles because of their asymmetric payoff profile. They have a 100% E quity ,
medium sensitivity to changes in the underlying equity. These bonds are affected by the The payoff of Convertible Bonds 0% B onds
10%
The conversion right provides the bond holder with a better-of-two-choices option. At maturity, share price performance and volatility movements as well as changes in interest rates and the surpasses the returns achieved by
100% B onds
the Convertible Bonds are worth the higher of (a) their redemption value (the price at which the issuer’s credit profile. The majority of new issues are launched as balanced Convertibles. either pure bonds or equities.
issuer had agreed to buy the bonds back) or (b) the market value of the underlying shares. 8%
Equity alternative (deep-in-the-money) 4% 9% 14% 19%
Annualised Volatility
In other words, a Convertible Bond is a straight bond with an embedded equity call option. Due Convertible Bonds where the underlying share price trades significantly above the conversion
Source: RMF Research
to this call option, the Convertible will participate in any increase of the underlying equity, while price are highly sensitive to changes in the equity, whereas their sensitivity to changes in
the fixed income portion provides capital protection, should the share price fall. interest rates and/or credit spreads is low. These bonds trade at an insignificant premium or
even a small discount to parity. Deep-in-the-money Convertibles will almost certainly be MARKET
converted into the underlying shares at maturity.
CHARACTERISTICS Global Overview The Convertible Bonds market has been growing over the last decade. The data indicate this trend
Payoff profile will continue in the future as both companies and investors become more aware of the benefits of
Price Behaviour of Old New Capital Gain/ Cash- Total Convertible Bonds. The following map depicts the capitalisation of outstanding Convertible
Yield Instrument Hybrid Instrument Equity Alternative Convertibles
Share Price + 25%
Equity
Price
130
Price
162.5
Loss
32.5
flow
1.5
Return
0.3
164 Bonds divided by geographic region (as of December 2001).
162.5

Convertible Bond
Convertible Bond 135 164.0 29.0 4.4 0.2
135
ity
Share Price unchanged
130
Par Equity 130 130.0 0.0 1.5 0.0 120
Europe
Asia (ex Japan)
rice USD 137 bn
rtible P
Convertible Bond 135 135.0 0.0 4.4 0.0
USD 29 bn
Conve
Share Price - 25% 97.5
Equity 130 97.5 -32.5 1.5 -0.2
North America Japan
USD 213 bn USD 91 bn
Bond Floor Convertible Bond 135 120.0 -15.0 4.4 -0.1 Share Price
Premium
Source: RMF Research Source: RMF Research
Convertible price

Global Performance 250


across Asset Classes In the long run, Convertible
200 Bonds can outperform pure
equity and/or pure bond port- The Convertible Bonds Market: USD 470 bn Source: Merrill Lynch

Value Index
Stock price
folios. The studies further show Long-only investors including dedicated CB Funds
150 Market Participants
Source: RMF Research that CBs can replicate the upside The strategy is to generate above average returns via capital gains and interest income while
movements of the share prices enjoying downside protection and lower volatility. Studies show that Convertible Bond portfolios
100 ML-G300 Global Convertibles without the corresponding volatility.
The x-axis displays the underlying share price while the y-axis represents the price of the Con- MSCI Global Equities have outperformed traditional portfolios (50% bonds and 50% equities) on a global basis from
vertible Bond. The dotted diagonal expresses the intrinsic value called parity. Parity represents JPM Global Bonds 1993 to 2000. During this period, they even outperformed pure equity portfolios (CBs returned
the value that the investor would receive upon conversion of the bond. Parity is a lower boun- 50 9.92% p.a., while equities returned 9.07% p.a.) (study by Jefferies).

Dec 94
Jun 95
Dec 95
Jun 96
Dec 96
Jun 97
Dec 97
Jun 98
Dec 98
Jun 99
Dec 99
Jun 00
Dec 00
Jun 01
Dec 01
Jun 02
dary for the price of the Convertible. The yellow line outlines the Convertible‘s fair value. If the Hedge Funds
share price increases, the fair value of the Convertible Bond rises as well. As the share price CB arbitrage is a typical Hedge Fund strategy. The arbitrageur is long a Convertible and short the
increases, the relationship between shares and bonds becomes more direct until the bond price Source: Bloomberg underlying shares according to the CB‘s sensitivity to its underlying (delta), in order to extract the
behaviour and risk profile resemble characteristics of the underlying equity. On the other hand, Convertible‘s ‘cheapness’. If the share price falls, the CB becomes more bond-like and declines
if the share price falls, the bond‘s sensitivity to its underlying share price will decrease and the Correlation Matrix for Intermediat Intermediate- less than the share price, so the trader buys back some shares. Similarly, if the share price rises,
Long-Term Long-Term Mortgage-
bond will not decline to the same extent as the equity. The level which will prevent the Con- Convertibles and other Convertible Large-Cap Small-Cap
Treasury
e-Term Treasury
Corporate
Term
Backed Real Estate the Convertible becomes more equity-like and the trader sells more shares. If it is possible to
Bonds Stocks Stocks Treasury Bills Corporate
vertible from falling further down is shown in the above graph as the bond floor (grey) which is major Asset Classes Bonds Bonds Bonds Bonds Securities
repeat this operation on several occasions, the trader will always be buying low and selling high.
also a lower boundary for the price of the Convertible. Convertible Bonds 1.00
Large-Capitalisation Stocks 0.83 1.00 Equity investors
Small-Capitalisation Stocks 0.80 0.79 1.00
Similarly to straight debt, a Convertible contains the risk of the issuer not being able to repay the Long-Term Treasury Bonds 0.36 0.36 0.12 1.00 As equity investors need or want full upside exposure, their strategy would be to buy deep-in-the-
principal at maturity. This credit risk is expressed in the graph as the steep fall of the bond floor Intermediate-Term Treasury Bonds 0.32 0.28 0.07 0.93 1.00 money CBs. They could often generate an income advantage as the coupon yield is typically
Treasury Bills -0.01 -0.09 0.02 0.00 0.25 1.00
as well as the bond price on the left-hand side. Long-Term Corporate Bonds 0.51 0.51 0.30 0.92 0.91 -0.01 1.00
higher than the dividend yield. Furthermore, they enjoy the benefit of the embedded call option
Intermediate-Term Corporate Bonds 0.52 0.48 0.33 0.90 0.94 0.19 0.97 1.00 on the underlying equity as well as free downside protection, although that may be rather far
The best risk-return profile is located in the red area where the Convertible’s potential upside is Mortgage-Backed Securities 0.42 0.35 0.10 0.87 0.91 0.14 0.95 0.93 1.00 away. The investors could also take advantage of in-the-money CBs trading at a discount to
Real Estate -0.02 -0.23 0.34 0.04 0.09 0.25 0.07 0.16 -0.01 1.00
the greatest while the downside risk is relatively low. RMF focuses on Convertible Bonds priced parity.
in that area. Source: Ibbotson Associates and Goldman Sachs
Fixed income investors
Correlations above are generally calculated using monthly total returns over the period 1973- Fixed income investors tend to buy out-of-the-money CBs that are trading with yields close to
2000. The exceptions are Mortgage Backed Securities, which use the period 1976-2000, and their corporate bond equivalents but contain the added bonus of upside participation of the
Real Estate which uses quarterly returns for the period March 1978-September 2000. underlying share price.
SUCCESS FACTORS RMF INVESTMENT GROUP
The following factors are critical for the success of a Convertible Bond investor: RMF Investment Group is the leading provider of Alternative Investment
Solutions, specialising in Hedge Funds, Leveraged Finance, Private Equity
 Asset allocation skills because of the wide divergence between returns of sectors and and Convertible Bonds. Focused on the institutional market, RMF’s
countries over certain periods target clients include pension funds, insurance companies, banks, large
corporations and distribution channels. RMF’s headquarters is in Switzer-
 State-of-the-art models to keep up with the ever increasing sophistication of the other land, however the Company also has physical presence in the
market participants major financial centres.

 Credit skills to assess the corporate bond-type credit risk RMF commenced activities as an operative Hedge Fund Manager in 1992
with an exclusive mandate for one of the world’s most prestigious Market
 Relationships to investment banks for access to new issues and stock borrowing Neutral Hedge Funds. Over the years, RMF has continued to focus on
(CB arbitrage) servicing investors by providing comprehensive products and solutions
and is regarded as an innovator in the Alternative Asset Management
 Market timing skills to protect the capital in extended phases of equity market weakness Industry.

 Risk management skills to avoid unwanted exposure to all types of risk including interest In May 2002, RMF was acquired by the Man Group creating the largest
rate and currency risk independent Alternative Investment Manager in the market, with approxi-
mately USD 20 billion under management (excluding Real Estate and
 Proprietary trading experience and mentality to take advantage of the relative value Private Equity). As of 30 June 2002 RMF had funds under management
characteristics of the instrument of approximately USD 9.5 billion.

RMF is a process driven organisation, and one of the few organisations


SUMMARY

Convertible Bonds
in the financial services industry to have achieved the ISO 9001: 2000
 In recent years, the Convertibles market has grown at an accelerated pace. More and more Certification for Quality Management Systems.
companies are willing to look at the advantages of financing through Convertibles, and they
find good demand from various investors such as Hedge Funds, Convertible Bond funds or
investment banks. We believe that this trend will continue and that this market will steadily
gain significance in the future

 Convertible Bonds are instruments that are beneficial to both investors and issuers

 Convertible Bonds are an asset class with risk-return characteristics that are superior to CONTACT
those of pure bonds, pure equities, or a blend of bonds and equities For further information please contact:
Client Relations Team
 The successful management of Convertible Bond portfolios depends on various factors such
as asset allocation, security selection and credit skills, state-of-the-art models as well as good RMF Investment Consultants
relationships to investment banks for access to new issues Huobstrasse 16
8808 Pfäffikon/SZ
Switzerland
Phone +41 (0) 55 415 87 10
Fax +41 (0) 55 415 87 94
www.rmf.ch info@rmf.ch

200/Q2_02
An Introduction to the Asset Class
Disclaimer

The content of this documentation is for your information purposes only and constitutes neither a
request, nor an offer, nor a solicitation, nor a recommendation to buy, sell or make an investment in the
described investment instruments or to enter into or conclude other transactions of any kind. The
information provided herein is not intended to provide sufficient basis on which to make an investment
decision. Potential investors should note that alternative investments can involve significant risks and the
value of an investment may go down as well as up. Furthermore, we recommend you consult your bank,
or investment and/or tax adviser. Past performance is never an indication or guarantee of future
performance.
Information contained herein is provided from the RMF database or obtained from sources that RMF
considers to be reliable. However, although RMF has taken professional care in gathering and updating
this material and information, it does not assume any liability in the case of incorrectly reported or
incomplete information, accuracy or correctness. All projections, valuations and statistical analyses are
provided to assist the recipient in understanding the basics of alternative investments. Such projections,
valuations and analyses may be based on subjective assessments and assumptions and may use one
among several alternative methodologies (and other methodologies may produce different results).
Accordingly, such projections, valuations and statistical analyses should not be viewed as facts and
should not be relied upon as a prediction of future events.
The information in this documentation is not intended for persons and organizations subject to U.S.
federal, state or local law or to the law of any foreign jurisdiction prohibiting the use or attention of this
information whether on the basis of domicile, nationality or for other reasons. This document and all
information contained within is proprietary information of RMF and its affiliates and may not be
reproduced or otherwise disseminated in whole or in part without prior written consent from RMF. A member of the Man Group
SUCCESS FACTORS RMF INVESTMENT GROUP
The following factors are critical for the success of a Convertible Bond investor: RMF Investment Group is the leading provider of Alternative Investment
Solutions, specialising in Hedge Funds, Leveraged Finance, Private Equity
 Asset allocation skills because of the wide divergence between returns of sectors and and Convertible Bonds. Focused on the institutional market, RMF’s
countries over certain periods target clients include pension funds, insurance companies, banks, large
corporations and distribution channels. RMF’s headquarters is in Switzer-
 State-of-the-art models to keep up with the ever increasing sophistication of the other land, however the Company also has physical presence in the
market participants major financial centres.

 Credit skills to assess the corporate bond-type credit risk RMF commenced activities as an operative Hedge Fund Manager in 1992
with an exclusive mandate for one of the world’s most prestigious Market
 Relationships to investment banks for access to new issues and stock borrowing Neutral Hedge Funds. Over the years, RMF has continued to focus on
(CB arbitrage) servicing investors by providing comprehensive products and solutions
and is regarded as an innovator in the Alternative Asset Management
 Market timing skills to protect the capital in extended phases of equity market weakness Industry.

 Risk management skills to avoid unwanted exposure to all types of risk including interest In May 2002, RMF was acquired by the Man Group creating the largest
rate and currency risk independent Alternative Investment Manager in the market, with approxi-
mately USD 20 billion under management (excluding Real Estate and
 Proprietary trading experience and mentality to take advantage of the relative value Private Equity). As of 30 June 2002 RMF had funds under management
characteristics of the instrument of approximately USD 9.5 billion.

RMF is a process driven organisation, and one of the few organisations


SUMMARY

Convertible Bonds
in the financial services industry to have achieved the ISO 9001: 2000
 In recent years, the Convertibles market has grown at an accelerated pace. More and more Certification for Quality Management Systems.
companies are willing to look at the advantages of financing through Convertibles, and they
find good demand from various investors such as Hedge Funds, Convertible Bond funds or
investment banks. We believe that this trend will continue and that this market will steadily
gain significance in the future

 Convertible Bonds are instruments that are beneficial to both investors and issuers

 Convertible Bonds are an asset class with risk-return characteristics that are superior to CONTACT
those of pure bonds, pure equities, or a blend of bonds and equities For further information please contact:
Client Relations Team
 The successful management of Convertible Bond portfolios depends on various factors such
as asset allocation, security selection and credit skills, state-of-the-art models as well as good RMF Investment Consultants
relationships to investment banks for access to new issues Huobstrasse 16
8808 Pfäffikon/SZ
Switzerland
Phone +41 (0) 55 415 87 10
Fax +41 (0) 55 415 87 94
www.rmf.ch info@rmf.ch

200/Q2_02
An Introduction to the Asset Class
Disclaimer

The content of this documentation is for your information purposes only and constitutes neither a
request, nor an offer, nor a solicitation, nor a recommendation to buy, sell or make an investment in the
described investment instruments or to enter into or conclude other transactions of any kind. The
information provided herein is not intended to provide sufficient basis on which to make an investment
decision. Potential investors should note that alternative investments can involve significant risks and the
value of an investment may go down as well as up. Furthermore, we recommend you consult your bank,
or investment and/or tax adviser. Past performance is never an indication or guarantee of future
performance.
Information contained herein is provided from the RMF database or obtained from sources that RMF
considers to be reliable. However, although RMF has taken professional care in gathering and updating
this material and information, it does not assume any liability in the case of incorrectly reported or
incomplete information, accuracy or correctness. All projections, valuations and statistical analyses are
provided to assist the recipient in understanding the basics of alternative investments. Such projections,
valuations and analyses may be based on subjective assessments and assumptions and may use one
among several alternative methodologies (and other methodologies may produce different results).
Accordingly, such projections, valuations and statistical analyses should not be viewed as facts and
should not be relied upon as a prediction of future events.
The information in this documentation is not intended for persons and organizations subject to U.S.
federal, state or local law or to the law of any foreign jurisdiction prohibiting the use or attention of this
information whether on the basis of domicile, nationality or for other reasons. This document and all
information contained within is proprietary information of RMF and its affiliates and may not be
reproduced or otherwise disseminated in whole or in part without prior written consent from RMF. A member of the Man Group

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