- What is it? A convertible bond is a fixed-income corporate debt security that yields interest payments, but can be converted into a predetermined number of common stock or equity shares. The conversion from the bond to stock can be done at certain times during the bond’s life and is usually at the discretion of the bondholder. As a hybrid security, the price of a convertible bond is especially sensitive to changes in interest rates, the price of the underlying stock, and the issuer’s credit rating. A convertible bond pays fixed-income interest payments, but can be converted into a predetermined number of common stock shares. The conversion from the bond to stock happens at specific times during the bond’s life and is usually at the discretion of the bondholder. A convertible bond offers investors a type of hybrid security that has features of a bond, such as interest payments, while also having the option to own the underlying stock.
- Convertible Bond ETFs offer investors exposure to convertible bonds. Convertible bonds are securities that have features of both equity and debt, making them hybrid instruments.
- Is it investing, speculating, or gambling? There are cash flows from dividends and potential capital appreciation of bonds and/or the stocks if bonds are converted to stocks. Therefore, it is an investment.
- What is the upside? Interest payments. Potential capital appreciation of bonds and/or stocks. Past performance: the oldest closed end fund is BCV (inception 1971), CAGRÂ since 1988 10.15%, best year 50.45%
- What is the downside? Decrease in interest payments, potential capital depreciation of bonds and/or stocks. Past performance: the oldest closed end fund is BCV (inception 1971), since 1988 worst year was -39.37%, max drawdown was -41.89%
- Who is on the other side of the trade? Professional money managers, other investors, corporations issuing convertible bonds
- What is the investment vehicle? Convertible bonds can be bought individually, or multiple convertible bond can be held within mutual funds, closed end funds (CEFs) or exchange traded funds (ETFs). I will be covering ETFs and CEFs in this article.
- What does it take to be successful? Long term conviction, periodic contributions & rebalancing, buying more when prices drop, trimming profits if position grows larger than chosen allocation (and is trading at a profitable price).
- Who is getting a cut? Asset managers via expense ratios, examples ICVT 0.20%, BCV 1.20%
- How does it impact your portfolio? Personally, I am considering a 3 to 4% allocation. Correlations: Convertibles to S&P500 ≈ 0.81. Convertibles to Gold≈ 0.18. Convertibles to Utilities ≈ 0.44. Convertibles to REITs ≈ 0.58. Convertibles to US long treasuries ≈ -0.24. Bottom line, convertible bonds are highly correlated to the US stock market.
- Should you invest? Maybe. I am considering a 3 to 4% allocation to this asset class.
Now, let’s look at the past performance of Convertible Bonds.
BCV vs an S&P 500 index fund: December 1988 – November 2020
BCV vs an S&P 500 index fund: December 20, 2000 – December 21, 2020
The Deep Value ETF Accumulator rankings for the 10 Convertible Bond ETFs and CEFs (5 years old and older):
The Deep Value ETF Accumulator rankings for the 10 Convertible Bond ETFs and CEFs (10 years old and older):
The 4 top ranked Convertible Bond funds head-to-head comparisons (5 years and older):
ICVT vs BCV vs ECF vs CWB: July 2015 – November 2020
ICVT vs BCV vs ECF vs CWB: June 5, 2015 – December 22, 2020
The 4 top ranked Convertible Bond funds head-to-head comparisons (10 years and older):
BCV vs ECF vs CWB vs CHY: May 2009 – November 2020
BCV vs ECF vs CWB vs CHY: April 16, 2009 – December 22, 2020
Stated objectives of 5 top ranked Convertible Bond ETFs & CEFs:
ICVT – The iShares Convertible Bond ETF seeks to track the investment results of an index composed of U.S. dollar-denominated convertible securities, specifically cash pay bonds, with outstanding issue sizes greater than $250 million. Potential for upside participation and downside protection – Convertible bonds are uniquely positioned to offer the growth potential of stocks, but with the income and downside risk management characteristics of traditional bonds. Seek to guard against rising rates – In rising rate environments, stocks tend to outperform bonds. Since a convertible bond’s price is influenced by the value of its underlying equities, their prices are generally less influenced by changes in interest rates than other fixed income securities. Diversified – Convertible bonds have demonstrated low correlations to traditional bond markets and can potentially provide attractive diversification benefits within a broad portfolio.
BCV – Bancroft Fund Ltd. operates as a closed-end, diversified management
investment company and invests primarily in convertible securities,
with the objectives of providing income and the potential for capital
appreciation; which objectives the Fund considers to be relatively equal,
over the long-term.
ECF – Ellsworth Growth and Income Fund Ltd. operates as a closed-end,
diversified management investment company and invests primarily in
convertible securities and common stock, with the objectives of providing
income and the potential for capital appreciation; which objectives the
Fund considers to be relatively equal, over the long term, due to the
nature of the securities in which it invests.
CWB – The SPDR® Bloomberg Barclays Convertible Securities ETF seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Bloomberg Barclays US Convertible Liquid Bond Index (the “Index”). Seeks to provide exposure to the market of U.S. convertible securities with an issue amount of at least $350 million and a par amount outstanding of at least $250 million. Convertible bonds are bonds that can be exchanged, at the option of the holder, for a specific number of shares of the issuer’s preferred stock or common stock
Rebalanced on the last business day of the month.
CHY – Calamos Convertible and High Income Fund. The Fund seeks total return through capital appreciation and current income by investing in a diversified portfolio of convertible securities and high yield corporate bonds. Aims to provide consistent income through monthly distributions set at levels the investment team believes are sustainable. By investing at least 80% of its assets in convertible and non-convertible income securities, the fund provides an enhanced fixed income strategy. Seeks to be less susceptible to rising interest rates than traditional fixed income funds. Invests in a broad range of security types to actively manage risk/reward characteristics over full market cycles. Judicious use of leverage seeks to enhance overall returns by achieving a positive spread on investments over borrowing costs. The fund offers an attractive monthly distribution and potential way to manage risk by employing securities that engage in upside equity movements with less downside susceptibility. It seeks to be less sensitive to interest rates by investing in lower-duration bonds.
Thank you for taking time to read this article. If you found it useful, please share it with a friend.
Respectfully yours, Micah McDonald, aka the Deep Value ETF Accumulator
Disclosure: We currently hold no positions in any securities mentioned in this article. We are considering starting a position in ICVT within the next 72 hours. I am not a professional investment advisor. Please perform you own due diligence or seek the advice of a Registered Investment Advisor before investing in any security mentioned in this article. This website contains affiliate links to M1 Finance and Google AdSense.