Investors are accepting weaker terms on convertible bonds to capitalize on the artificial intelligence boom, pushing risk levels to heights last seen during the pandemic. Recent AI-linked deals have featured coupons nearing 0%, leaving buyers dependent entirely on stock appreciation for profits.
The convertible bond market has surged this year, with volume already exceeding 2021's peak. The trend recalls the zero-rate era's tech stock mania, when companies like Peloton and Beyond Meat issued bonds with equally aggressive terms. Many of those deals collapsed as shares tumbled, leaving bondholders with worthless conversion options and minimal income.
As interest payments vanish, these instruments increasingly function as leveraged equity wagers. A key market metric tracking equity sensitivity recently reached its highest point in two years, underscoring how returns now hinge on stock movements rather than conventional bond factors.
Tech firms lead the charge, including AI cloud provider CoreWeave Inc. and European developer Nebius Group NV, which raised $4.5 billion last week after a prior $9.75 billion offering. Lenovo Group Ltd. has also entered the fray.
"The convertible market now includes numerous issuers demonstrating strong revenue and profit growth, though some higher-risk players remain," said Joe Wysocki of Calamos Investments, where he serves as a senior portfolio manager.
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The AI convertible bond surge has split market participants. While some hail it as an ideal environment, others caution it may become a costly misadventure. The current rush resembles 2021, when low-coupon deals dominated before rate hikes revealed shaky fundamentals.
Convertible bonds traditionally offered a balance of fixed income and equity upside, but the latest structures tilt heavily toward speculation. According to Nicolas Cremieux, head of convertible bonds at Mirabaud Asset Management, near-zero coupons eliminate the "paid to wait" advantage, forcing investors to rely solely on stock gains. With tech equities experiencing swings, bonds tied to these shares face growing volatility.
The current boom mirrors patterns seen during previous tech-driven market cycles. In 2020-2021, companies with unproven business models issued convertibles with minimal yields, betting on perpetual growth. When the Fed raised rates, many collapsed - a warning for today's AI-fueled issuers.
The bottom line: Investors are forfeiting standard protections to bet on AI through convertibles, turning these instruments into a high-risk wager on tech's trajectory - one that may echo past speculative busts.