The Hunt for Asymmetry - Identifying Attractive Risk-Adjusted Investments in the Convertibles Universe

All right, hello everybody, and thank you for joining the next presentation of the Investing and Alternatives Traders Expo. We have Mario Valente with us. Mario is a Portfolio Manager and Deputy Chief Investment Officer at STAM. He is responsible for sourcing and monitoring positions across the firm's strategies, while also serving as a principal spokesperson for the team's investment philosophy with clients. Prior to joining Sam, Mario was the Director of Investment Grade Research at Zazov Associates, a multi-billion dollar investment firm specializing in convertible security management. He was previously a Senior Credit Analyst at Sandelman Partners, a multi-strategy hedge fund focused on fixed income relative value investing. Mario started his buy side asset management career with Citadel in 2001, where he was one of the first credit research analysts hired into the convertible arbitrage group. Mario holds a BA from Stanford University, where he majored in economics. He has also completed graduate level coursework in statistics and data science at MIT. Mario earned the Chartered Financial Analyst CFA Charter in 2011, and currently serves on the board for the CFA Society of San Francisco, and the Education Advisory Committee for the CFA Institute. Without further ado, ladies and gentlemen, Mario Valente. Mario, the floor is yours. Hi, thank you so much for the intro. I appreciate it. Hi, everyone. Again, my name is Mario Valente. I am the Deputy Chief Investment Officer at Stansberry Asset Management, and we really appreciate your attendance for today's presentation. We're excited to share with you our thoughts on discovering asymmetric investment opportunities through a somewhat puzzling but opportunistic asset class known as convertible bonds. Today, we're going to highlight an investment strategy that will reduce volatility while providing consistent returns, a tactic which we find extremely compelling, especially in a world with rising economic economic and geopolitical uncertainty. So before we dive in, I'd like to begin by spending a few minutes talking about my firm, Stansberry Asset Management. We are a SEC registered investment advisor, headquartered in Dallas, with offices in New York, California, and Washington as well. And in just 10 short years since inception, we're very proud of the fact that we've grown to over $1.3 billion in assets under management, which is a testament to the wealth creation that we've engendered for our clients through tailored and intelligent investment management. When we started the firm, there were two pillars of investment philosophy that we embraced to comprise the foundation of our business. The first is the idea of active management. Most advisors rely on passive investment vehicles like ETFs or choose to follow a rigid investment formula like a 60% stock, 40% bond allocation. At our firm, our client portfolios solely consist of single securities selected through our own internal research efforts. And we are constantly titrating the stock versus bond allocations in our client portfolios based on our own informed view of their relative value. The second is the idea of low correlation. With so much macroeconomic and geopolitical uncertainty in the world, we wanted to create a protective buffer around our client accounts. By incorporating low correlation strategies into our clients' portfolios, we are attempting to minimize the influence of negative black swan events that inexplicably continue to occur. So these philosophical decisions have resulted in significant outperformance versus our benchmarks over the last five years, particularly during periods of significant volatility like the Fed tightening of 2022 and Liberation Day of 2025. And as a result, our AUM has grown significantly, reflecting increasing trust and deeper relationships amongst our client base. And lastly, I'll just say a little bit about myself. Approximately 25 years ago, I started my asset management career at Citadel inside the firm's credit research group, where I had the privilege of learning how to invest across the convertible bond and high yield landscape from the industry's best and brightest. And using my trade craft, I spent the next 16 years focused on investing across the corporate credit spectrum for institutional clients like pensions, endowments and life insurance companies. And finally, I came to Stansbury asset management nearly nine years ago with the simple idea that we could import these tactical low correlation strategies for individual clients and do it with considerable success. So, so enough about me and my firm, let's switch gears and dive into what I really wanted to talk about and what you came here to learn. So, convertible security is a traditional bond that can be converted or exchanged into a specific number of shares of the issuer's common stock. The bond component provides income potential and reduced volatility derived from the stated coupon in maturity and the claim to principal. And like other bonds, a convertible value can fluctuate with changes in interest rates and the credit quality of the issuing company. Convertible securities generally have a lower coupon than corporate bonds, but they usually offer a yield advantage over the common stock dividend. The equity component provides unlimited capital appreciation potential derived from an option that provides the right to convert into a fixed number of common shares. Because of this feature, when convertible securities ensure, they can be redeemed at the market value of the underlying common shares or at their face value, whichever is higher. Because convertible instruments combine characteristics of stocks and traditional fixed income securities, they provide investors with unique opportunities for managing risk and enhancing returns. Like stocks, convertibles typically offer upside appreciation in rising equity markets and are less sensitive to rising interest rates. And like bonds, convertibles provide income and potentially less exposure to equity downside in declining markets. Therefore, one of the more attractive attributes of convertibles is that many have historically participated in a greater portion of their underlying stock's upside performance than their downside. This dynamic creates a risk-reward profile that is compelling to an investor who desires equity participation and is willing to exchange maximum upside to mitigate a great deal of equity downside. Curiously, though, the U.S. convertible bond market has long been overlooked by asset allocators and investment managers, primarily due to its relatively small size and complexity. Convertibles are more complicated than their non-convertible brethren. And many investors simply lack the expertise required to analyze them. However, for managers with the requisite expertise, we believe convertibles are an excellent source of alpha, as the drivers of return are materially different than the non-convertible universe. Identifying attractive convertible opportunities requires one to understand the fundamentals of the issuer and the performance characteristics of each security. Even veteran fixed income investors can have a difficult time understanding the performance characteristics of convertibles if they lack direct experience trading in the market. This complexity is exactly what creates the opportunity for us as we have the experience and knowledge necessary to identify attractive issues. Moreover, the relatively small size of the market is not a limiting factor as we use convertibles as a complementary asset class across our portfolio strategies. So the behavior of a convertible security may take on either stock-like or bond-like characteristics, depending upon where the underlying stock is trading in relation to the bond conversion price. The security tends to become more equity -like as the price of the common shares rise, which means its participation in the stock's downside may increase. And as the underlying stock price falls, the convertible may act more bond-like, which means its participation in the stock's downside tends to decrease. It's important to note that convertibles are subject to the same risk factors as stocks and bonds, including market, interest rate, and credit risk. Broadly speaking, as you can see on the graph, there are three types of convertible bonds. Number one, bond-like or busted convertibles, which are characterized by high yields and high conversion premiums. Given that the equity option is out of the money, these securities behave more like corporate bonds. Number two, we have total return or balanced convertibles, which are characterized by moderate conversion premiums and some equity sensitivity. And finally, we have equity-like convertibles, which are characterized by lower conversion premiums and a high degree of equity sensitivity. And so, as you can see, each type is distinguished by its sensitivity to movements in the underlying stock. And the same security will change categories as its equity price fluctuates over time. So why do we consider investing in convertible security? Well, as you can see in the chart on the left, convertibles offer an asymmetric risk reward profile in which the upside opportunity can exceed the downside capture. And as you can see on the chart on the right, over the last 35 plus years, which have included multiple periods of elevated volatility, U.S. convertibles have produced equity-like performance, but with lower volatility. U.S. convertible new issuance set a record in 2025. And momentum has continued with primary market activity getting off to a very strong start in 2026. Market strategists estimate that this year's new issuance volume will be elevated due to coupon savings demand and a steady refinancing pipeline paired with strong investor appetite for longer-term upside optionality. Also, artificial intelligence-linked spending, M&A activity, and selective investment grade and hybrid issuance should also support deal flow throughout the year. Also, the yields of longer-term, longer-maturity U.S. treasuries, which are the foundation of corporate borrowing costs, have remained relatively elevated. Right? So, as a result, companies have found convertible securities desirable because they offer lower interest expense costs for corporations compared with straight debt. New issuance is key because it helps balance and diversify the market and expands the investment opportunity set of balanced convertibles, which are most favored by investors. However, I'm going to spend the remainder of this time discussing busted convertibles, which are traditionally neglected by larger institutional investors. So, as a reminder, convertibles become busted when the underlying stock price has declined materially below the conversion price. And as a result, busted convertibles have the least equity sensitivity of the three types. They effectively behave like straight bonds. And one of the main reasons we consistently find good value in busted convertibles is that the market has been structurally favorable for opportunistic buyers like ourselves. Allow me to explain. So, the majority of convertible debt, which resides in the balanced or equity -like parts of the convertible curve, is generally held by large convertible arbitrage hedge funds like Citadel. And these investors are long the convertible and short the equity, trying to exploit pricing inefficiencies between the two markets. However, once a convertible bond becomes busted, it becomes more debt-like and the ARB investors will look for opportunities to cover their short positions and sell the convertibles. Historically, that has created excellent buying opportunities as the ARBs are motivated to sell the convertibles and lock in the gain on their short equity position. Furthermore, most convertible bonds are not rated by agencies like Standard & Poor's and Movies. Therefore, most traditional buyers of fixed income, like insurance companies and pension funds, are typically not permitted to own convertible bonds. And so, as a result, busted convertibles becoming neglected, but very much opportunistic asset class tranche of the market. And so, when the COVID pandemic hit the US, the Fed kicked its asset purchases into high gear. And so, in the span of a few months, the Fed's balance sheet nearly doubled to $7 trillion. And as a result, over the subsequent 12 months, bond yields skyrocketed, as evidenced in the five-year Treasury yield graph shown here on the top half of the page. While growth stocks rose to near all-time highs, as depicted by the ARC Innovation ETF graph shown in the lower half of the slide. These conditions were ideal for convertible bond issuers in 2021, as shown in the green rectangle, as dozens and dozens of high-growth companies issued bonds with little to no coupons, while their underlying stock prices were significantly inflated. And so, fast forward to present day, and those same convertibles that were issued during the boom times of 2021 have absolutely plunged in value. Because, number one, yields have exploded to the upside, reducing the bond value of the convertible. And number two, the stock prices have plunged amongst this universe of small-cap, high-growth companies, reducing the equity value of that same convertible. So, what do we look for? So, remember, I mentioned earlier, that for various reasons, busted convertibles have been traditionally neglected by the larger asset management community for a myriad of reasons. And as a result, we're finding some amazing asymmetric investment opportunities in this esoteric asset class. We believe that the most optimal risk-reward profiles of these securities reside in the price range of 70 to 80 cents on the dollar, with yields to maturity ranging from 8 to 10%. We think that a lot of these convertibles possess credit fundamentals that are far superior than typical high-yield issuers with standard high-yield bonds maintaining similar yields. We also like bonds with 2 to 4-year maturities, because prudent management teams will likely begin the repayment and or refinancing planning of these securities in the next 12 to 24 months, which is very near-term in the lifetime of the company. We also love healthy liquidity on the issuer's balance sheet. A lot of the companies that we examine have cash balances that are sometimes 50 to 100% larger than their total debt outstanding. Yet the market continues to punish the prices of the convertibles simply because they're overlaugged. We also like simple capital structures, meaning that the balance sheet may only have 2 or 3 debt issues outstanding. In this particular scenario, it's easy to see how management is thinking about their liability schedule. As capital structures become more complex, liability management becomes a much more difficult job for the CFO with the potential for greater downside variance. And finally, perhaps the most important data point we look for as we conduct due diligence on busted convertibles is, has the management team demonstrated a history of debt reduction via bond buybacks and or equity for debt exchanges? Right. In these scenarios, not only is the management team indirectly communicating to the market that they are vigilant with prudent balance sheet management, but they're also providing an implicit backstop for that particular bond issue. And in our minds, that's a green light. So this, this last slide here depicts what we believe is perhaps the most compelling characteristic of owning busted convertibles. In the bond indenture, which is the legal contract between the bond issuer and bond holder that governs the note, convertible bonds contain language such that an all cash takeover of the issuer will trigger a bond put by bond holders at par. So what does that exactly mean? Well, let's say that the equity of the issuer is trading at $10 per share and an all cash acquisition is announced for $14 per share. Stockholders realize an appreciation of 40%, which is a great outcome. But what about convertible bond holders? Well, let's say that the same issuer's convertibles were trading at $0.75 on the dollar. The put provision in the indenture means that bond holders can put the bonds back to the company at par, thus realizing a 33% return. So in this scenario, bond holders can realize an upside outcome that is nearly the same as equity holders. However, right, the risk reward is completely different because convertible bonds possess much better downside protection than their underlying stocks because they're fixed income instruments. So, so let me just, I'll stop right there. That's all I have because I know we're pretty close to the time limit. If you have any questions or if you're interested in learning more about Sam, please contact us. You can, you can find our info on the slide here. Either, either capture our QR code, send us a message on LinkedIn, Facebook, or X, or feel free to email me directly. You can email me at Mario.Valente. Thanks so much for your time. And we look forward to hearing from you, Sam. Take care. Awesome, Mario. Thank you for that presentation. It looks like we do actually have one question. Would you be interested in taking the question? Can you read it to me or can I see it? Okay. So someone asked, is your company related to Porter Stansberry? Oh, yes. Our, our, our investment, our asset management firm is related to Porter Stansberry. It was actually founded out, out of the Stansberry research newsletter that was created approximately 25 plus years ago. And so almost a large portion of our client base are current or former student Stansberry research newsletter subscribers. Awesome. That is all the questions that we have today. I definitely appreciate your insights. Mario is a great presentation. And again, if you all have any questions, feel free to reach out to Mario directly. He left his information on the screen for you. So thank you again, Mario. And we do still have presentations going for the rest of the day. And if you are interested in learning more about investing in alternatives, make sure that you tune in. Thank you, Mario, for your time. Thank you for having me.