The AI craze is sweeping through convertible bonds: Investors are abandoning bond protection in order to bet on AI price increases.

Convertible bond investors chasing the artificial intelligence boom are actively abandoning traditional protection clauses, pushing risk appetite in the market to its highest level since the height of the 2021 pandemic frenzy.

Global convertible bond issuance has reached $147 billion this year, an increase of over 50% compared to the same period last year, surpassing the previous record set in 2021. AI-related companies such as CoreWeave and Nebius Group have flocked to this market, with some newly issued bonds offering coupons near zero, as buyers bet that rising share prices of the issuers will replace interest income as the primary source of return.

This trend is diminishing one of the core appeals of convertible bonds—the interest income that buffers investors when the underlying stock falls . The mean delta, a key metric for measuring the equity-like nature of convertible bonds, is currently around 64%, the highest level since 2021. Meanwhile, recent volatility in tech stocks due to bubble concerns further highlights the risks of this bet.

Zero-coupon bonds reappear, equity-like characteristics hit a five-year high.

Convertible bonds give investors the right to convert the bonds into stocks at a specific price, thus possessing both debt and equity characteristics. When the coupon rate approaches zero, the holder effectively forgoes the "yield during the waiting period" and bets all returns on the performance of the underlying stock.

According to Bloomberg data, the current average delta of the convertible bond market is about 64%, the highest level since 2021. Nicolas Cremieux, head of convertible bond business at Mirabaud Asset Management, said that convertible bonds had offered considerable yields in recent years, allowing investors to "sit back and wait for returns," but now they are instead attracted to stock options.

The lessons of 2021 are still fresh in our minds. At that time, companies such as Peloton Interactive and Beyond Meat issued billions of dollars in convertible bonds with 0% coupon. Subsequently, as interest rates soared and stock prices collapsed, investors were left with bonds that neither paid interest nor had any guarantees, suffering heavy losses.

AI companies led the issuance, breaking historical records in scale.

Technology companies are the main drivers of this wave of IPOs.

CoreWeave provides software runtime services for AI applications, and Lenovo Group, as an equipment manufacturer, has both completed large-scale convertible bond financing . Just last week, Nebius Group NV, which focuses on AI cloud platforms, raised $4.5 billion through the convertible bond market, bringing its total to over $14 billion, including the $9.75 billion it had previously issued. This issuance includes notes maturing in 2030, with a coupon rate ranging from 0% to 0.5%.

At the same time, tech giants like Alphabet are increasingly turning to traditional credit markets to finance infrastructure spending, with investment-grade deals related to hyperscale data centers offering yields that are approaching junk bond levels.

Concentrated risks and hidden dangers: Multiple exposures to the same theme

Some market participants are taking a cautious approach to the current momentum.

Adam Marden, portfolio manager at T. Rowe Price, stated that as the convertible bond market becomes more equity-like, investors must differentiate between winners and losers rather than indiscriminately buying the entire asset class. He pointed out that while AI may bring a leap in productivity and create a "dream environment" for convertible bonds, it could also be "the biggest waste of money in human history." Therefore, carefully studying the details of each bond's terms and understanding its protective clauses is crucial.

Joe Wysocki, senior vice president and portfolio manager at Calamos Investments, believes the current environment is fundamentally different from that of 2021. "A certain degree of repetition could always happen, but interest rates are in a very different position today," he said. "There are many issuers in the current convertible bond market demonstrating excellent fundamental momentum in terms of revenue and profitability."

However, Stephan Bach, senior portfolio manager at Sparinvest, points out a deeper risk: the experience of 2021-2022 suggests that portfolios can unknowingly develop highly concentrated exposure to the same underlying theme as investors diversify their AI exposure through equities, credit, and increasingly equity-like convertible bonds. "The key is not to avoid strong themes, but to ensure that enthusiasm for a theme doesn't override valuation discipline or portfolio construction principles," he says.

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