Convert to Convertibles…Bonds That Is

ETF Trends

Imagine a bond exchange traded fund that better-than-average potential for capital appreciation relative to most bond funds that throws off a decent yield while not being too sensitive to interest rate fluctuations.

At first glance, such an ETF may seem hard to come by, but the SPDR Barclays Convertible Securities ETF (NYSEArca:CWB) . Convertible bonds are hybrid securities that have a penchant for performing well even as interest rates rise. That explains CWB racing to an all-time high in August as 10-year Treasury yields jumped and investors fretted about Federal Reserve tapering. [Convertible Bonds to Fight Rising Rates]

Convertible bonds can be looked as “best of both worlds” securities. Since the bonds can be converted into stock of the issuer, convertibles are often more intimately correlated to equities than other segments of the bond market. But like bonds, convertibles promise coupon payments and return of principal at a set date. The utility of an ETF like CWB does not end there.

“For conservative investors, convertible bonds can add valuable diversification and help smooth the ups and downs of a traditional stock-and-bond portfolio,” reports Eleanor Laise for Kiplinger’s Retirement Report.

The supposed trade-off with convertibles is lower credit quality or higher risk of default, but over 40% of CWB’s portfolio is rated Baa, A or AAA, according to State Street data.

“Convertible securities tend to be subordinate to other debt securities issued by the same issuer. Also, issuers of convertible securities are often not as strong financially as issuers with higher credit ratings,” according to CWB’s prospectus. “Convertible securities generally provide yields higher than the underlying stocks, but generally lower than comparable non-convertible securities.”

Investors are compensated for the risk. CWB has a current yield of 3%. More importantly, the ETF is up nearly 18% this year, a performance that easily outpaces the Vanguard Total Bond Market ETF (BND) as well as the largest Treasury, high-yield and municipal bond ETFs. CWB has also been less volatile than ETFs holding long-dated Treasuries. [Convertible ETFs Races to All-Time High]

And if U.S. interest rates rise in earnest, remember the ticker CWB. “Over the past 20 years when the ten-year Treasury yield rose one percentage point or more, convertibles delivered negative returns in only one of those periods and posted double-digit gains in six,” according to Calamos Investments data cited by Kiplinger’s.

SPDR Barclays Convertible Securities ETF

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ETF Trends editorial team contributed to this post.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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