John WyliePartner/Portfolio Manager

Tony Pata, CFAResearch Analyst

Seeking Secular Growth with Lower VolatilityWe believe that investors should seek to invest in companies that are addressing unmetneeds and innovating the products and services of tomorrow. These companies typicallyexhibit higher rates of growth and growth that is secular, not tied to the ebbs and flowsof the broader economy.

We find innovation and disruption in all sectors; however, they are particularly prevalentin healthcare, technology and consumer sectors. While mega-cap tech such as Apple,Google and Facebook get all the press, we believe some of the best investmentopportunities are in small- and mid-cap companies, those earlier in their corporatelifecycle, often playing the disruptor role. Opportunities we see include cloud computing,machine learning, artificial intelligence, blockchain technology, smart cars, roboticsurgery, gene therapy, synthetic biology and e-commerce among others.

Convertible bonds, a hybrid security with equity- and bond-like characteristics, offeraccess to these fast-growing companies and sectors, which are primarily issued by small-and mid-cap companies for growth capital. Convertible bonds’ equity component (optionto convert into common stock) can provide investors the opportunity to participate inmost of the equity upside, while their bond attributes (coupon and principal) offersinvestors potential downside protection with less volatility than equities.

Innovation & Disruption: Seeking Companies with Secular Growth

Summer 2019

Investment Insights: ConvertiblesCapitalizing on Innovative & Disruptive Secular Growth with Lower Volatility

DISRUPTION INNOVATION

UNMET NEEDS

Robotics

eCommerce (D2C)

Restaurants

Insurance

Smart Farming

Transportation

Home Service Plans

Food

Fintech

Cloud Computing

Artificial Intelligence

Internet of Things

Block Chain

Smart Mining

Precision Medicine

Clean Energy

Payments

Gene Therapies

Synthetic Bio

Car-TSmart

Cars

Pet Families

Last Mile

Social Media

KEY TAKEAWAYS Convertible bonds can give

investors access to the most innovative, fastest-growing companies and sectors of the market with lower volatility

A hybrid security, convertibles participate in rising equity markets yet help protect against volatility and downside risk

Active management can add value through security selection

Our edge: specializing in dynamically growing small-and mid-cap companies to optimize the equity option and selecting balanced convertible securities to protect in market downturns

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As you can see in Exhibit 1, the convertible universe is rich with investment opportunities predominantly in innovative, fast-growing small- and mid-cap companies and sectors. As of June 30, 2019, 94% of convertibles were issued by small- and mid-cap companies and approximately 50% of the convertible universe was comprised of technology and healthcare companies.

INVESTMENT INSIGHTS – SUMMER 2019

1Percent by market cap distribution is based on the numberof issues using Russell’s market cap breakdown (small cap<$6B, mid cap $6B-$35B and large cap >$35B).

Mid Cap 23%

Large Cap 6%

Small Cap 71%

0% 5% 10% 15% 20% 25% 30% 35%

Cons Staples

Materials

Real Estate

Energy

Industrials

Utilities

Cons Discretionary

Comm Services

Financials

Health Care

Technology

Sector Weight

ICE BofA Merrill Lynch US Convertibles

Russell Midcap Growth

Russell 2000 Growth

Exhibit 1. Innovative, High-Growth Sectors Comprise the Largest Weights in Convertible Universe

Market Cap Distribution1

The Challenge Is Managing VolatilityWe believe long-term investment success requires exposure to innovative, high-growth companies, many of which arefound in the small- and mid-cap segment of the market. However, small- and mid-cap growth stocks often exhibit highermarket volatility. So how can investors benefit from innovation and future growth, yet manage volatility and downsiderisk?

Over the last 20 years, convertible securities captured most of the equity upside and more importantly, acted as “shockabsorbers” to help protect investor capital during drawdowns. As illustrated in Exhibit 2 below, balanced convertiblesparticipated in 73% of the S&P 500 upside and 58% of Russell 2000 Growth in rising markets and only 61% of the S&P 500downside and 50% of the Russell 2000 Growth in declining markets. This smoother ride gives convertibles one of the mostattractive long-term return/risk profiles compared to other asset classes.

Exhibit 2. Convertibles Capture Upside but Protect in Drawdowns

11.0

-10.9

14.3

-11.7

18.9

-21.7

15.2

-17.9

-30

-20

-10

0

10

20

30

Rising Markets (61 periods) Declining Markets (18 periods)

Aver

age

Rolli

ng 1

Year

Ret

urns

TR US All Cap Focus Index(Balanced Convertibles)ICE BofAML US Convertibles Index

S&P 500 Index

Russell 2000 Growth

As of June 30, 2019. Average return of rolling one-year returns, quarter over quarter, going back 20 years using the S&P 500 as the market proxy. Source: eVestment, NicholasInvestment Partners. Results may vary for different time periods.

As of June 30, 2019. Source: FactSet, Nicholas Investment Partners.

20 years ending June 30, 2019

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Typical New Issue

Bond Value

Balanced(with asymmetrical risk/reward)

Bond Substitute Equity Substitute

Stock Price

Busted/Out of the money At the money In the money

What Gives Convertibles Their Attractive Risk/Return Profile?Convertible bonds are hybrid securities that pay interest and principal like a typical corporate bond and yet also have thepotential of equity participation through an embedded equity option. The bond is convertible into common stock at a strikeprice set above the common stock value at the time of issuance. In this way, they provide the potential for upsideparticipation like a stock with the certainty of downside protection from its bond attributes.

Not all convertibles have the same risk/return profile. If this embedded conversion option is far out-of-the money, i.e., thecurrent stock price is far below the strike price, the convertible security trades as if it were a straight bond (left side ofExhibit 3). If it is far in-the-money, i.e., the stock price is far above the strike price, the convertible bond has greater equitysensitivity and trades in tandem with the underlying stock (right side of Exhibit 3).

Balanced convertibles are a class of convertible securities that, as their name suggests, retain an asymmetrical risk/rewardprofile, balancing equity upside potential and downside protection from the underlying principal and coupon of the bond.

INVESTMENT INSIGHTS – SUMMER 2019

Exhibit 3. Convertible Bonds – An Overview

Balanced convertible issues are the largest segment of the convertible universe today (Exhibit 4). This provides activemanagers an ample opportunity set to add value through security selection.

Exhibit 4. Convertible Market Composition

Bond Substitutes

26%

Total Return/Balanced

54%

Equity Substitutes

20%

As of June 30, 2019. Source: ICE BofAML US Convertibles; Nicholas Investment Partners. Based on delta distribution. Bond substitutes (Convertibles with deltas <35%),Balanced (Convertibles with deltas between 35%–90%). Equity substitutes (convertibles with deltas >90%).

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Why Not Just Buy High Yield Bonds?

INVESTMENT INSIGHTS – SUMMER 2019

Further, convertibles have historically had lower default rates than high yield bonds, indicating the higher quality ofcompanies in the convertible universe. As highlighted in Exhibit 6, the average default rate of convertible issues was lessthan high yield bond issues from 2003 to 2018, especially during the last recession in 2008-9 when high yield defaultsincreased to 17.0% versus 2.2% for convertibles.

As of June 30, 2019. Source: Barclays US Convertible Strategy, FactSet, Monis,ICE BofA Merrill Lynch, Nicholas Investment Partners.

Exhibit 5. Convertibles Have Greater Exposure to High-Growth Sectors

We believe convertibles offer investors a distinct opportunityset from high yield corporate bonds.

Convertible bonds help diversify a company’s capital structureand investor base and are typically issued at 5-year or shorterduration. For many fast-growing small- and mid-capcompanies, convertibles are often their only issued bond.

We also find that most new convertible issues are in the mostdynamic, innovative sectors at the forefront of the digitaleconomy. Many are disruptors with large addressablemarkets with the potential for high growth rates and withlong secular tailwinds. These high-growth companies issueconvertible securities to fund their growth through capitalspending, R&D or through acquisitions.

We want to be invested in companies that can control theirown destiny. A slowing global economic cycle would likelylead to higher default rates, particularly for companies tied to“old economy” cyclical sectors, which account for most high-yield issuers. For example, 13% of the high-yield universe areenergy companies versus 3% of the convertible universe. Incontrast, 31% of the convertible universe are technologycompanies versus 7% for the high-yield universe (Exhibit 5).

% of IndexICE BofAML

US Convertibles

Bloomberg/Barclays

US High Yield

Communications 9.1 20.0

Consumer Discr 8.2 16.1

Consumer Staples 0.7 3.9

Energy 3.4 13.0

Financials 10.9 11.5

Healthcare 18.2 9.1

Info. Technology 31.3 6.6

Industrials 5.0 7.5

Materials 1.1 9.4

Utilities 6.8 2.9

Exhibit 6. Convertibles Offer Lower Default Rates (2003 to 2018)

As of December 31, 2018. Source: Barclays US Convertible Strategy; Nicholas Investment Partners. Data reflects bond default rates of Barclays US Convertibles and US HighYield universe.

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018US Convertibles (Bonds Only) 1.3% 0.0% 0.4% 0.6% 0.7% 0.9% 2.2% 1.3% 1.4% 1.2% 1.1% 1.6% 1.7% 3.1% 0.3% 1.2%US High Yield Bond 5.6% 2.5% 4.3% 1.0% 0.6% 6.6% 17.0% 1.6% 1.1% 2.0% 0.4% 1.9% 3.5% 3.6% 1.3% 1.8%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

% D

efau

lt Ra

tes

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127

103

141

211

124

267

184

107

153

188

92112

83 75 74

138

111

82 88108

140

51

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

0

50

100

150

200

250

300

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Billions

# of

New

Issu

es

# of Issues $ Billions

With the recent tax-law changes to the deductibility of interest expense, convertibles may be even more attractive thanstraight debt, a factor we believe will continue to drive new issuance trends in this low interest rate environment (Exhibit7).

Although investors may be tempted to allocate a portion of their portfolio into high yield bonds, seeking yield in a sustainedlow interest rate environment, we believe convertibles offer a more attractive alternative.

INVESTMENT INSIGHTS – SUMMER 2019

Exhibit 7. Strong New Issuance Trends Among High-Growth Sectors

YTD Issuance by Sector (%)

Cons Discr 19.3 Cons Staples 1.0 Energy 1.3 Financials 6.3 Health Care 25.3 Industrials 10.0 Materials 1.0 Technology 19.6 Telecom 3.3 Utilities 12.9

As of June 30, 2019. Source: ICE BofA/Merrill Lynch Global Convertibles Chartbook, Nicholas Investment Partners.

Opportunity for Active Management to Add ValueWe believe convertibles are a relatively misunderstood asset class with different types of market participants. Activemanagers can add value through security selection by optimizing the embedded equity optionality in analyzing a company’sgrowth drivers and through credit analysis of the bond structure to identify convertibles with an asymmetric return/riskprofile–those convertible securities with the potential to participate in most of the underlying equity’s upside price actionand less of the downside.

In the last 25 years, active convertible managers have delivered equity-like returns with lower volatility than equitybenchmarks, as shown in Exhibit 8.

Exhibit 8. Active Management in Convertibles Adds Value

As of June 30, 2019. Source: eVestment, Nicholas Investment Partners. Results may vary for different time periods. Past performance is no guarantee of future results.

5

6

7

8

9

10

11

12

2 6 10 14 18 22

Gro

ss R

etur

n (%

)

Standard Deviation

25 Years ending June 30, 2019

BofA ML High Yield Master II

Barclays Aggregate Bond

Median US Convertible Manager

S&P 500

BofA/ML AQ Convertibles

Russell 1000

Russell Midcap

Russell 2000

T. Reuters US All Cap Focus (Convertibles)

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INVESTMENT INSIGHTS – SUMMER 2019

Our EdgeWe are a specialist in innovative, dynamically growing companies. Our focus on understanding the future growth prospectsof a company enables us to optimize the embedded equity option in convertibles. Our principals’ 30+ years of experienceinvesting in these hybrid securities enables us to build convertible portfolios with predominantly balanced issues, those thatmaintain the asymmetrical payoff/protection profile offered in these distinctive securities.

A dedicated convertible portfolio can provide exposure to innovative growth companies and sectors while delivering asmoother ride for investors. We believe that a convertible portfolio built from an equity-focused investment process, suchas ours, has the potential to add the most value over time.

ABOUT USNicholas Investment Partners, L.P. is an independent, employee-owned and majority women-owned investment boutique focused oninvesting in dynamic, less efficient markets such as US small- and mid-cap equities and convertible bonds. We believe that changecreates opportunity. We invest in dynamic companies with accelerating revenue and/or earnings growth in which our research confirmsthe company’s growth is sustainable and the company’s stock is a timely investment. Our edge comes from combining fundamentalequity and credit research with the objectivity and efficiency of quantitative analytics. We have a results-driven and client-centric culturecentered on building lasting and value-added relationships with a select group of institutional and private wealth clients and consultants.

Disclosure: Nicholas Investment Partners, L.P. (“Nicholas”) is an independent investment adviser registered with the SEC. Registration with the SECdoes not imply a certain level of skill or training. The firm maintains a complete list and description of performance composites, which is availableupon request. Policies for valuing portfolios, calculating performance, and preparing presentations are available upon request. Past performance is noguarantee of future results. Current performance may be lower or higher than the performance presented. This information is intended for institutions,consultants and qualified investors only. No part of this material may be copied or duplicated, or distributed to any third party without written consent.

Nicholas does not guarantee the success of any investment product. There are risks associated with all investments and returns will vary over timedue to many factors such as changing market conditions, liquidity, economic and other factors. The value of investments can go down as well as up,and a loss of principal may occur. Although Nicholas attempts to limit various risks, risk management does not imply low risk. All risk models areinherently limited and subject to changes in economic, political and market conditions, as well as changes in the strategies’ holdings, among otherthings, which could affect the risk profile of any portfolio managed by Nicholas. Small- and mid-cap companies may be subject to a higher-degree ofrisk than larger more established companies’ securities. The liquidity of the markets for these small and mid-cap companies may adversely affect thevalue of these investments. Concentrated or sector strategies are expected to maintain higher exposures to a limited number of securities or sectorswhich could increase the volatility, market, liquidity and other risks of the strategy. The use of leverage in any investment strategy may significantlyincrease these risks.

Some information herein reflects general market commentary and the current opinions of the author which are subject to change without notice. It isprovided for general informational purposes only and does not represent investment, legal, regulatory or tax advice and should not be construed as arecommendation of any security, strategy or investment product. There is no guarantee any opinion, forecast, or objective will be achieved in thefuture. The information, charts and reports contained herein are unaudited. Although some information contained herein was obtained fromrecognized and trusted sources believed to be reliable, its accuracy and completeness cannot be guaranteed. Unless otherwise noted, Nicholas is thesource of illustrations. References to specific securities, issuers and market sectors are for illustrative purposes only. Nicholas does not undertake tokeep the recipients of this report advised of future developments or of changes in any of the matters discussed in this report.

Index returns are provided as a general indicator of the investment environment existing during the time periods shown and are provided forcomparison purposes only. The returns for the index do not include any transaction costs, management fees or other costs. Investors may not makedirect investments into any index. Investors should consider comparing the performance of any potential investment to other benchmarks and indicesthat are representative of their particular investment objectives, horizons and risk tolerances.

P.O. Box 9267 │ Rancho Santa Fe, CA 92067 │ (858) 759-4545 │ www.nicpartners.com