European convertibles taking off as bond yields rise
* Risk-averse investors seek cheaper exposure to stocks
* Record outflows from bonds; convertibles see inflows
* Convertible index beats corp bond, STOXX 600 this year
PARIS, July 5 (Reuters) - Appetite for convertible bonds is taking off in Europe as risk-averse institutional investors seek to escape rising bond yields but remain wary of buying into stocks directly.
European companies have issued nearly $15 billion of convertibles so far this year, with companies from Arcelor-Mittal to Volkswagen embracing the trend.
Convertibles give holders the right to turn their bonds into the issuing company's shares, offering exposure to the higher returns available on equities but with interest and principal repayments putting a floor under potential losses.
Because they usually pay a lower interest rate than regular bonds, convertibles are also a cheaper way for companies to raise cash - even more so as bond yields rise.
"We are at an inflexion point,", said Antoine de Guillenchmidt, Goldman Sachs Head of Equity Capital Markets France/Nordic and Equity-Linked EMEA.
"After 12 months of extremely favourable interest rate conditions for corporates, the tide might be turning with recent tensions and volatility in the credit markets and the rising long-term yields. This puts convertible bond financing back in the corporate finance 'toolkit' for issuers."
For investors, convertibles are a way to play the asymmetric risks now building between fixed income and equities. They can avoid being trapped by retreating bond prices as the U.S. economy recovers, while capturing a potential rally in equities without being fully exposed to the risk of a drop in stocks.
Jean-Edouard Reymond, head of convertibles at UBI, which has 2.7 billion euros ($3.5 billion) invested in convertible bonds,
said convertibles typically capture about 70 percent of gains in the underlying companies' stocks, while suffering only 50 percent of the losses.
"Pension funds and insurers are loving them, and rising government bond yields are making convertibles even more attractive," he said.
Including Alcatel-Lucent's convertible sale last week, companies have raised $14.8 billion in convertibles so far this year in Europe, according to Morgan Stanley, versus 2012's total of $22 billion and $11.5 billion issued in 2011.
The trend in Europe reflects a global convertibles boom, with $46.6 billion issued so far this year, nearly twice as much as in the first half of 2012, according to Dealogic data, with the bulk issued by U.S. companies.
While the Fed's plan to scale back its quantitative easing programme has triggered record outflows from bond funds - $23 billion last week, according to EPFR Global - convertible bonds have been largely immune.
"The 'equity component' of the convertible becomes a buffer against the volatility we're seeing in segments of the fixed income market such as high-yield bonds," said Pierre Alexis Renaudin, head of European convertible bonds at Morgan Stanley.
"It's a good way to keep risks relatively low while at the same time getting exposure to the upside in equities. In that sense, it's one of the best-performing asset classes on a risk-adjusted basis."
Convertible bond funds tracked by Thomson Reuters Lipper have instead enjoyed brisk inflows since the beginning of the year, with net inflows seen in the past nine weeks in a row.
"There's just no outflows here, on the contrary, we've seen $7 to $8 billion of fresh money coming in since the beginning of the year," UBI's Reymond said.
Convertible bond prices have also proved resilient. The UBS Global Convertible Bond index is up about 6 percent in 2013, beating high-yield and investment-grade corporate bond indexes and the STOXX Europe 600 stock index .
(Additional reporting by Alexandre Boksenbaum-Granier, Editing by Nigel Stephenson and Catherine Evans)