Market Pulse: An easy entry into convertible securities
March 5, 2014
Last week Tesla Motors announced they raised $2 billion in a sale of convertible debt in order to raise money for a battery plant, which might be located in Nevada.
This put a spotlight on the convertible bond market, a market most retail investors know little about.
Investors rarely own the convertible securities, partly because the convertible bond market is relatively small and illiquid. That has changed with the introduction of SPDR Barclays Convertible Securities ETF (ticker CWB).
This easy-to-purchase security gives investors access to a vehicle that benefits from a rising stock market, but with less volatility.
Convertible bonds are fixed-coupon securities that grant the holder the ability to exchange the bond for common or preferred stock at a specified price.
Convertibles tend to be issued with a conversion price about 20 to 30 percent above the current level.
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Convertibles generally yield less than the company's standard corporate debt because their embedded call option has value. They are senior to equity in the capital structure, but usually subordinate to traditional bonds.
As a hybrid security that combines the features of a stock and a bond, convertibles are often classified as fixed-income securities. That's wrong.
Since the bonds can be converted into stock of the issuer, convertibles move more closely with equities than with other segments of the bond market. In fact, the correlation between SPDR Convertible Securities and the S&P 500 is 87 percent.
The SPDR Barclays Convertible Securities ETF (CWB) returned 21 percent in 2013 and has an annual return of 9 percent over the last three years.
Its top holdings are convertible securities from Wells Fargo, Gilead Sciences, Bank America, Intel and VeriSign. CWB yields 3.4 percent and is taxed at the ordinary income rate. Its expense ratio is 0.40 percent.
CWB will lag in a very strong bull market, but will do better when prices are moving sideways, especially if interest rates are stable or falling.
That's what is happening now. In 2014 the S&P 500 is unchanged but CWB is up five percent. I suspect this ETF will attract a lot of interest in 2014.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.