Renewed European Institutional Interest in Convertible Bonds: Strategic Positioning and Risk-Adjusted Returns in a Post-Recessionary Landscape

The European convertible bond market has emerged as a focal point for institutional investors in the post-recessionary environment of 2023–2025. Driven by a confluence of macroeconomic normalization, strategic arbitrage opportunities, and evolving regulatory dynamics, this asset class is reshaping its role in diversified portfolios.

Market Positioning: A Resurgence in Convertible Arbitrage

According to a report by Resonanz Capital, European institutional flows into convertible bonds have surged since 2023, fueled by a 60% increase in global convertible bond issuance—peaking at $90 billion in 2023 and remaining robust at $88 billion by Q4 2024 [1]. This influx has reinvigorated convertible arbitrage strategies, which exploit pricing inefficiencies between convertible bonds and their underlying equities. Hedge funds and institutional investors have capitalized on this environment, with convert-arb funds delivering double-digit returns in 2023 and maintaining momentum into 2024 [1].

The strategy’s appeal lies in its dual exposure to equity upside and fixed-income downside protection. As equity volatility normalized post-recession, the cost of hedging equity risk through convertibles became more attractive. Additionally, the European Central Bank’s cautious approach to interest rate normalization has preserved the relative value of convertibles compared to traditional bonds, where duration risk remains elevated [1].

Risk-Adjusted Returns: A Mid-Tier Proposition

While convertible bonds have regained traction, their risk-adjusted returns position them as a mid-tier alternative compared to other asset classes. Data from JPMorgan Private Bank indicates that European convertibles are projected to generate a 6.7% annualized risk-adjusted return over 2023–2025 [2]. This figure lags behind private equity (8.2%) and real estate (7.5%) but outperforms traditional fixed income, which struggles with inflation-linked erosion.

The risk-return profile of convertibles is typically evaluated using the information ratio, which measures excess returns relative to a benchmark per unit of risk. For European convertibles, this metric suggests a balance between capital preservation and growth potential, making them suitable for investors seeking moderate risk with equity-like upside [2]. However, this performance hinges on macroeconomic stability and the absence of regulatory shocks.

Navigating Risks and Regulatory Shifts

Despite the optimism, European investors must remain vigilant. The normalization of interest rates, though gradual, could compress convertible bond valuations by reducing the discount rate applied to future cash flows [1]. Additionally, evolving trade policies and potential deregulation in private markets introduce uncertainty, particularly for convertible bonds tied to cross-border issuers [1].

Regulatory scrutiny under the European System of Central Banks’ balance of payments monitoring also adds complexity. While no specific convertible bond data is captured in these reports, broader investment trends suggest that institutional flows could face tighter oversight, affecting liquidity and pricing dynamics [2].

Strategic Implications for Institutional Investors

For European institutions, the current environment presents a strategic inflection point. Convertible bonds offer a unique blend of income, equity exposure, and downside protection, particularly in a low-yield world. However, their role in a portfolio should align with an investor’s risk tolerance and time horizon. As JPMorgan notes, convertibles are best suited for investors seeking “moderate growth with controlled volatility” rather than aggressive capital appreciation [2].

Institutional allocators should also consider the structural advantages of convertible arbitrage, which allows for dynamic hedging and capital efficiency. With issuance volumes remaining elevated, the supply-demand imbalance may persist, creating favorable conditions for arbitrageurs to exploit mispricings [1].

Conclusion

The renewed institutional interest in European convertible bonds reflects a recalibration of risk and return in a post-recessionary world. While the asset class offers compelling strategic positioning and mid-tier risk-adjusted returns, its success depends on navigating macroeconomic and regulatory headwinds. For investors willing to balance caution with opportunity, convertibles present a nuanced yet valuable addition to diversified portfolios.

Source:
[1] Convertible Arbitrage: The 2023–2025 Comeback, [https://resonanzcapital.com/insights/convertible-arbitrage-the-2023-2025-comeback]
[2] Alternative Investments in 2025: Our top five themes to watch, [https://privatebank.jpmorgan.com/nam/en/insights/markets-and-investing/ideas-and-insights/alternative-investments-in-2025-our-top-five-themes-to-watch]