As 2024 draws to a close, the financial market's excitement centers around Exchange-Traded Funds (ETFs), which have seen significant capital inflows this yearAmong the top ten ETFs in terms of net capital inflows in 2024, there’s a notable standout: a bond ETFSpecifically, the Bosera Convertible Bond ETF has amassed a striking net inflow of 29.63 billion yuan, ranking ninth among all ETFs by December 23.

Convertible bonds are typically characterized by their dual nature of offering both investment security and potential growth opportunitiesHowever, the first half of 2024 proved challenging for these financial instruments, as fluctuations in the market raised questions about their underlying valuesWith government measures favoring a looser monetary and fiscal policy since late September, investor sentiment has shifted, boosting the risk appetite for equity assets and thereby positively influencing the option value of convertible bonds.

By the close of trading on December 24, the Hai Fu Tong Shanghai Convertible Bond ETF and the Bosera Convertible Bond ETF reported price increases of 0.53% and 0.39%, respectively

These ETF products track indices of investment-grade convertible bonds and exchangeable bonds on the Shanghai Stock Exchange, showcasing their robust performance compared to other bond ETFs in the market.

So, what has attracted such investment into convertible bonds this year?

Throughout 2024, capital investment has consistently favored convertible bondsNotably, the Bosera Convertible Bond ETF, which is the largest of its kind in the market, currently holds an impressive scale of 38 billion yuan with a remarkable net inflow of 29.63 billion yuan this year reflecting a staggering increase of over 350%. Mid-year trends indicate strong enthusiasm as well; as of December 20, the ETF’s size had grown to 37.3 billion yuan with 6.3 billion yuan added in just the past two weeks alone.

According to data from Wind up to December 23, the Bosera Convertible Bond ETF saw a net daily inflow of 700 million yuan, placing it second in the rankings among over a thousand ETFs available in the market, just behind the Southern CSI 1000 ETF

• AI Agents Reshape Web3, Crypto Landscape
• Over a Trillion in Funds Has Entered the Market!
• Major Moves! The Stock Wizard's Buying Spree
• Bitcoin Surpasses $100,000 for the First Time
• Developers Vie for Prime Urban Land

Additionally, examining the five-day net inflow volume reveals total net inflows of 1.877 billion yuan - again, the second highest.

Moreover, the Hai Fu Tong Shanghai Investment-Grade Convertible Bond ETF has also experienced growth this year, with net growth exceeding 4.5 billion yuan, marking a tenfold increase to nearly 5 billion yuan of assets under management.

What drives investors to prioritize convertible bonds at this moment?

According to Lu Liyang, the fund manager from Yongying Xin Xin Fund, the earlier part of the year saw convertible bonds struggle due to skepticism surrounding their underlying values amidst a challenging market environmentHowever, since the end of September when looser monetary and fiscal policies were set, the market has entered a phase characterized by abundant liquidity and increased risk appetite for equity assets, thus benefiting the recovery of the option value of convertible bonds.

High Hui, the fund manager for the Bosera Convertible Bond ETF, points out that the fund's large scale and excellent liquidity make it a prime target for allocation funds, leading to its rapid purchase and investment interest.

Another area of interest is the significant role of institutional investors who have emerged as an influential force in these market dynamics.

As we look to the future, fund managers encourage investors to actively consider opportunities during market corrections.

A review of the performance from the Hai Fu Tong and Bosera convertible bond ETFs shows annual returns of about 9% and 7%, respectively

With supportive policies, recent engagement in the equity market has markedly increased, pushing stock volatility higher, thus enhancing the implied option value of convertible bondsHow does this bode for future market performance?

Hai Fu Tong Fund asserts that convertible bonds currently present a low opportunity cost, particularly when institutional entities remain under-allocated with respect to convertible bondsThis scenario suggests a stronger probability of funds flowing back into the convertible bond marketPredictions for 2025 point toward a continued contraction in the net supply of convertible bonds, with existing stock potentially shrinking from over 700 billion yuan to around 600 billion yuanAmid these conditions of an "asset drought," some upward market potential persists.

Furthermore, Lu Liyang believes that current valuations of convertible bonds remain within a rational range relative to historical averages

Taking into account the potential return of option value and the superior timing advantages compared to equities, these assets still possess attractive cost-performance ratios.

From a supply and demand perspective, there’s a clear trend for convertible bond supply to decrease next yearIn a low interest rate environment, there’s also a chase for relatively high-yield assets, which, coupled with continued support from ample liquidity, could tighten the correlation between stocks and bonds and provide a favorable environment for upward valuation shifts in convertible bonds.

Moreover, observing market behaviors, the recent activities within small to mid-cap sectors, particularly among emerging growth stocks, highlight an uptick in interest for convertible bonds which align well with current market trendsThanks to ETF inflows and additional capital, trading activity in convertible bonds has increased, marking a rebound in liquidity.

Overall, the outlook for convertible bonds remains optimistic

Despite potential short-term volatility due to over-exhuberance in market sentiment surrounding large versus small cap stocks, it is advised that investors keep a keen eye and actively engage during market adjustments.

High Hui also notes that the relatively loose policy framework — particularly the potential for interest rate cuts in 2025 — indicates that bonds have already begun to price in such anticipated changesAs the yield on 10-year government bonds drops below 1.7%, the spread between equities and bonds approaches a two-standard deviation threshold, limiting any downward space for indices.

"Currently, convertible bonds are valued at a medium level, and with supportive factors in the equity market, it seems unlikely they would revert to their state from August to September of 2024. The downward protection is robustAdditionally, with the currently low premium rates for conversion, expanded transaction volumes and rising volatility are expected to further activate upward potential for convertible bonds," explains High Hui