Hybrid Bond Investment Increases Income and Reduces Some Risks.
Summer fun may include long drives along the coast in a two-seater cruising along with the top down. While the summer season has come and gone and it may be time to park the sporty auto and put the top back up as cooler seasons and inclement weather approach, consider this: Convertibles can be used in investing, too, and can offer more than just driving fun. Convertible Bonds, a hybrid investment, are always in fashion as part of any all-weather diversified investment portfolio.
Hybrids are all the rage with auto buyers. And convertibles are a perennial favorite of auto enthusiasts. Both can be part of a long-term investment portfolio, too.
Convertible Bonds may be unfamiliar to most investors but they are a great tool for helping to minimize risk in any investment portfolio. Convertible Bonds are hybrid investment vehicles that offer the best of both worlds – income now like a bond and the potential to capture appreciation later like a stock.
Get Paid While You Wait
Convertibles offer investors a fixed yield like any other bond. This regular income offers better downside protection than simply holding the stock. They also have a feature that allows the bond holder to trade in the bond for a certain amount of stock on a predetermined date. This feature makes these hybrid Bonds advantageous during inflationary times when stock prices might be increasing and other bonds drop in value. During market corrections or bear markets, investors receive interest while waiting for the next recovery or bull market.
Like any other bond, there is underlying credit risk of the issuer. The opportunity to convert also means that the Convertible Bond may track the underlying stock more closely and have higher volatility than straight bonds. Yet the hybrid nature of this investment provides corresponding benefits to help offset this risk.
Convertible Bonds as a Separate Asset Class Evolve
As an asset class, Convertibles have been around for more than 150 years. Since December 1973 through mid-2010, the Convertible Bond index has had total returns (interest plus appreciation) of 2736%, outpacing the government/corporate bond index by 943% and ending higher than the hi-yield (aka junk) bond index of 1585% (BofA / Merrill Lynch Convertible Research, 6/30/10).
Convertible Bonds have evolved with the times. In the past, many were issued by smaller companies that did not have other means of accessing capital. Over the past 15 years, Convertible Bonds have become more prevalent among larger brand name firms as well as corporate treasurers have added them to their mix of ways to finance companies without immediately diluting shareholders. They continue to be a go-to strategy for growing companies in technology, pharmaceuticals and bio-science sectors.
In the past Convertible Bonds were more prone to large swings in value because the window providing the option to convert was usually very distant. Many now offer windows to convert to stock that are relatively short: 3 to 5 years, reducing the bond investor’s needed holding period to cash out and get his money back with interest or a stock gain.
Convertible Bond Advantages
During Fed tightening, Convertibles have performed well. It is inevitable that interest rates will rise from their historically low rates with or without inflation. While the value of other government and high-quality corporate bonds will suffer when interest rates rise, Convertible Bonds will likely hold their value, continue to pay out interest and offer the potential of greater return when converted to stock. (For a white paper detailing this, please visit http://www.ClearViewWealthAdvisors.com and post a request).
1. Higher yield than most equities (presently > 3.5%)
2. Potential to capture appreciation
3. Enhanced diversification and lower potential risk resulting from low correlation with stocks and bonds
4. Track record of preserving capital
5. Unlike other bonds, Convertible Bonds have generally performed well during periods of Fed tightening to increase interest rates or inflationary periods.
