Convertible bonds are getting renewed attention as an asset class that offers investors exposure to stocks and bonds while softening the blow on the downside and promising a smoother ride along the way.
The surge in bond yields has spurred volatility across markets, with the
S&P 500
and
Nasdaq Composite
each having their worst October since 2018.
Eli Pars, co-chief investment officer at Calamos Investments—the largest U.S. manager of convertibles, with $34 billion in assets under management—says one way of thinking about convertible bonds is as a low-volatility equity strategy.
“Historically, over a full market cycle, investors have been able to earn similar returns to the equity market, but with about a third less volatility,” he says.
These bonds get their name from the feature that separates them from conventional debt. They are hybrid securities that pay a fixed interest rate and allow investors to exchange the debt for the issuing company’s shares if the stock price appreciates. They offer a combination of the downside protection of bonds and the upside potential of stocks.
“Convertibles are an interesting and often-overlooked option for investors to thread the needle in terms of equity exposure and bondlike exposure,” says Michael Arone, chief investment strategist at State Street Global Advisors.
Arone says the returns in convertible bonds have been “pretty good” in 2023, with total returns of 2% this year for the $3.4 billion
SPDR Bloomberg Convertible Securities
exchange-traded fund (ticker: CWB), compared with negative returns for traditional bonds. The $89 billion broad-market
iShares Core U.S. Aggregate Bond
ETF (AGG) is down 2.5% this year.
Over the past 12 months, the SPDR Bloomberg Convertible Securities ETF has returned 1.3%, according to Morningstar. It has delivered annualized total returns of 7.8% over the past decade.
Investors can play convertibles through mutual funds, exchange-traded funds, or individual securities. Unlike traditional stock and bond funds, where investors have plenty of choices, the Morningstar category of convertible funds has less than two dozen names, with a handful of ETFs.
Calamos has a long history in convertibles and a large stable of funds, including the flagship $837.2 million
Calamos Convertible
fund (CCVIX) and the $121.1 million
Calamos Global Convertible
fund (CAGCX), both of which are actively managed. In October, the firm launched its first convertibles ETF, the actively managed
Calamos Convertible Equity Alternative
(CVRT).
Pars is the lead manager of Calamos Global Convertible, which has delivered total returns of 3.6% this year, outperforming 98% of the funds in its Morningstar category. Over three and five years, though, the fund is in the bottom quartile.
Chiayi Tsui, an analyst at Morningstar Research Services, says active management is an advantage in this asset class. “Managing the equity sensitivity of a convertible bond portfolio is very important,” she says. “When your convertibles become like equity, they lose their ability to provide downside protection.”
On the passive side, two of the largest convertible ETFs are SPDR Bloomberg Convertible Securities and the $1.3 billion
iShares Convertible Bond
(ICVT), which is up 2.9% this year.
It’s important to take the long view when it comes to convertible bond funds. “Convertibles are almost never going to outperform equities, and during down markets they are almost never going to outperform bonds,” says Michael Youngworth, the head of global convertibles strategy at BofA Securities. “They are firmly in the middle.”
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