Convertible Bond Sales 101: Got Liquidity?
Only we’ve covered far too much of the “trading” side and not enough on the “sales” side.
Actually, change that to “nothing” on the sales side.
But that changes with the first interview in our series on institutional sales in different parts of the world.
Today, you’ll hear from a reader who works on the convertible bonds sales desk in Hong Kong and you’ll learn all about the group, including:
- How you make money on convertible bond sales vs. equity sales and how you get compensated.
- What your average day in the group will be like.
- How you’ll interact with traders when you work in sales, and whether or not they secretly hate you.
- Differences in the convertible bond market in the US and Europe vs. Asia.
Let’s get started:
Pre-Conversion to Sales
Q: Let’s start with the usual resume walkthrough. How did you get started in the industry?
In HK, I focused on convertible bonds in the standard ECM capacity at a bulge bracket bank. An opportunity came up to move over to the convertible bond sales desk, which is where I’ve been ever since.
Q: Not going to say where you went to school or anything?
A: It would make me too easy to identify, sorry. There aren’t a ton of foreigners in HK doing the same thing I am.
Q: OK, I’ll see if I can trick you into answering that one later anyway.
Stepping back for a second, could you explain what exactly convertible bonds are and what you do in convertible bond sales?
A: Sure. A convertible bond is that also has an equity call option embedded in it.
To investors, convertible bonds can be viewed as an investment that offers the best of both worlds – access to the upside potential of equities, but with a level of downside protection given that it is also a bond that (hopefully) is paid back at maturity if the stock doesn’t perform well.
The convertible bond sales desk of an investment bank sells and trades CBs with institutional investors such as hedge funds, mutual funds and asset managers.
Sales is involved with both primary (newly-issued bonds) and secondary activity (typical trading and market making).
The two main investor types involved in CBs are hedge funds (which may or may not engage in CB arbitrage by shorting the underlying stock) and outright CB investors which do not hedge their CBs and thus are taking a fundamental view that the credit/equity of the company will improve.
Q: OK, so it sounds like convertibles might be an interesting area if you want to move to a hedge fund in the future… but we’ll return to that one later.
What about breaking in… in the first place? Who are they looking for, and what are resumes and interviews like?
A: Few people break in straight from college. Most people come from some related background such as risk management for a trading desk, the middle office, or origination; I broke in from capital markets.
In terms of what interviewers care about, I think people are mostly concerned about your personality, intelligence and drive to succeed.
If you already have a related background, it’s low risk for the team to hire you because you have already demonstrated knowledge of and familiarity with the products.
Some questions that interviewers might ask:
- Why are you interested in working on the convertible bonds desk?
- What are your previous experiences that are related to convertible bonds?
- Do you know how convertible bond math works?
For the first question, you want to relate it back to convertibles being a “compromise” between debt and equity and how you’re interested in the field because you like both of those and don’t want to cover only one at the expense of the others.
For the previous experience question, again you need to relate it back to previous experience in equity or debt.
And if you haven’t had either of those, find a way to link some other type of analytical work you’ve done to convertibles and point out how you have the aptitude to do it math-wise.
Q: Another big question with recruiting in Asia is the language requirement. Do you need to speak fluent Mandarin to work on the convertible bond sales desk in Hong Kong?
A: No. I do not speak or write Mandarin or Cantonese at all.
My investors are mostly people from hedge funds who are based in Asia, Europe or the US. Even those clients based in Asia tend to be Western or at least Western-educated so local language skills are not really important.
Money, Sales, and Deals
Q: I see, it sounds like your group is quite different from something like IB where language skills would be required.
Can you walk us through an average day in your life on the convertible bond sales desk?
A: Sure. I get into the office at around 7:30 AM, and we usually start by having a brief meeting with traders that set the objectives for the day.
I will then call my clients and see what they are up to. As Gordon Gekko might say, “Lunch is for wimps,” so we don’t really take extended lunch breaks here.
I usually just step out of my desk to grab a sandwich back in the office and eat. In the afternoon, the European market opens and I’ll be dealing with European clients too. I usually leave the office by 6 PM.
Unlike equity sales, we do not have as much “client entertainment,” so it’s not as if we’re going out and doing the whole models and bottles thing every night. We’re busy during the day, but we have more free time at night.
Q: Wait, what? No models and bottles? How do you guys actually make money then?
A: I’m glad you brought that up, because it’s actually quite a bit different from equity sales.
The convertible bond market is an over-the-counter (OTC) “risk market,” meaning that the convertible bond desk makes money on bid-ask spreads rather than commissions.
In almost every trade the convertible bond desk makes, the desk is taking risk and trying to recycle that risk within the spread.
The size of the spread and how much value you can capture depends on how liquid the bond is and often how the market itself trades in the short term. The Asia CB market is much less liquid than the market in Europe or the US and the average spread is about 1 point.
For example, the CB desk might quote a bond 100 – 101 and if we agree to buy US $1mm of bonds at 100, we are taking on the risk that we can find buyers above 100 so we actually make money (or if we sell bonds at 101, we are taking the risk that we can find sellers below 101 to cover the sale).
On the other hand, equity sales teams generate revenue from brokerage commissions – you get paid a commission on whatever you execute and do not have residual risk from unfilled orders (i.e. if the clients says sell 100 shares of XYZ company at $100 and you only sell 50, you aren’t at risk to buy the other 50 shares).
Q: OK, so then how much is an average trade, and how many trades do you guys make in a day? How liquid is the convertible bond market?
A: An average trade is usually around $1 – 3 million USD. So unlike equities, we make money with a smaller volume of larger dollar-value trades rather than a larger volume of smaller dollar-value trades.
The convertible bond market in Asia is not liquid given the limited number of investors and the limited supply of paper.
There is also a lot of one-way momentum trading, and since a large portion of the investor base (outright CB investors) tends to be long-term holders the effective free-float at any one point in time can be rather limited.
Q: Do you think that’s just because you’re in Asia? Or are convertible bond markets elsewhere similar?
A: It’s largely an Asia thing; Europe and especially the US have much deeper markets. We just don’t have as much paper to trade or investors to call, but over time this lack of liquidity should start to change.
One thing that also holds the Asia liquidity back is the lack of stock borrow and the lack of liquidity in the underlying stocks.
Convertible bonds offer a chance to employ a market-neutral strategy (CB arbitrage) but that only works if you can at least hedge the equity, which requires stock borrow to short-sell the underlying stock.
The more stock borrow becomes available, the more hedge funds you will see attracted to Asian CBs which should result in more trading.
So the convertible bond market here is pretty much a momentum market.
If equities go up, convertible bonds go up, and vice versa. You can’t always make money regardless of market direction like you often can in Europe and the US.
Co-Workers & Pay
Q: You’ve mentioned trading and working with traders a few times.
How does your team work? How do salespeople interact with traders?
A: Each bank works slightly differently depending on how performance is measured and reward.
Some banks reward sales based on the volume of bonds they trade (which has its own obvious moral hazard) and others focus more on the profitability of their trades and the performance of the desk’s own book. Our desk is more of the latter so I will briefly describe that.
Typically, traders are in charge of making risk prices and managing the prop positions of the desk. The objective of sales is to assist the traders in managing their risk and facilitating client orders, often by using our insight into other potential buyers/sellers.
If traders tried to do this on their own, they would be spread too thin because they’re not only coming up with the ideas, but also attempting to execute them.
By letting us focus on knowing who all the clients are and what potential buyers are doing, the work is divided much more effectively.
Q: What about your co-workers on the desk? Who do you work with most closely?
A: I mainly interact with my traders (getting prices, sharing market color etc) and other CB sales guys as we try to match client flow amongst each other.
I also work with the origination team – so when our bank is selling a convertible bond offering, I would coordinate with the ECM team and provide them with pricing and appropriate structure.
On a sales & trading desk you don’t work as closely with your colleagues as you do in IB because everyone has their own clients and accounts and not everything is a group effort.
Q: Speaking of investment banking, how do salaries and bonuses compare? Can you get promoted more quickly on the markets side if you perform well?
A: Base salary is the same as what investment banking and bonuses are also fairly similar to IB at the entry-level.
The difference is that on the markets side, everything is more performance-dependent even at the junior levels. So if you perform well, you can get promoted more quickly and earn more money – but if you don’t bring in revenue, you also get laid off more quickly.
The “ceiling” for salespeople in terms of pay is probably several million USD per year, but keep in mind that post-financial crisis, fewer people in the industry make that much.
Q: And how is that pay determined? Does it depend on how well your desk has done, or is it more about your individual performance?
A: Different banks have different policies. Some banks pay their team based on how much volume the individual executes. Other banks, like ours, pay the team based on the profit & loss statement of the whole desk, which is split between the sales and traders.
I think the latter is a better way to compensate people because everyone’s incentives are aligned.
Some firms set objectives for traders just to get a certain volume done, so traders may execute at a bad price just to increase volume.
That ends up hurting everyone else, so I think it’s better to base compensation on the P&L of the desk as a whole and make sure everyone’s on the same page.
A Future in Convertibles?
Q: So let’s say you’ve worked in convertible sales for a few years and now you’re looking to move on and do something different – what are the exit opportunities?
A: That depends if you are looking to stay in finance or not. People staying in finance often go to a convertible bond fund either on the execution desks or in some analyst or portfolio management type role.
It’s rare to move into something like private equity or corporate development at a normal company because your skill set is very specialized when you work with convertibles, though you do have the benefit of a holistic view of both debt and equity markets.
So you get a trade-off similar to what you see in other specialized fields of finance: you position yourself to move to a fund that invests using your strategy or which invests in your security, but it’s much harder to move to something that requires a broader skill set.
Q: How does your new job compared to your past life in ECM? Any preference for one or the other?
A: Coming from an IB background, I have to say that this role is not as tangible compared to what you do in IB.
You do have a P&L you can point to, but no real work product to produce and take pride in. Most of your time is spent on the phone or building client relationships so it suits a different skill than IB.
But the work-life balance here is much better than my previous life in capital markets – it really is just market hours, and even if there’s a deal launching in the market I don’t stay late pulling all-nighters to get things done.
Q: Yeah, that makes a lot of sense. We’ve heard from previous interviewees how capital markets hours may not be as good as you imagine.
What do you think about trading vs. sales? Any thoughts on both of those as career options?
A: This really comes down to your personality, but I would suggest that you choose trading over sales because you provide more tangible value in trading.
It’s easier to point to your P&L in trading and take credit – whereas in sales, a lot of what we do is indirect and doesn’t result in an immediate sale or commission.
And, of course, if you’re interested in exit opportunities outside of finance you’re better off going to IB/PE in the first place.
One final note: everything I’ve said above applies to convertible bond sales.
Institutional sales in other areas is definitely different, so don’t interpret my thoughts as blanket statements that apply to everything in sales.
Q: Thanks. Yeah, we’re going to cover some of those areas soon so readers can get the full picture.
Thanks for your time – learned a lot about convertible bond sales!
A: No worries – enjoyed the chat.
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