Tag: convertible-bonds

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10 Questions & Answers On Convertible Bond ETFs & CEFs 1.4

  • 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), CAGR 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

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