Convertibles Cruise Into 2014

ETF Trends

Earlier this month, the Federal Reserve made official its plans to reduce its $85 billion-per-month in bond buying to $75 billion with reductions coming in equal parts from Treasuries and mortgage-backed securities.

Due to months of intense speculation regarding the arrival of tapering, investors pulled $22 billion from long-duration bond ETFs in the first 11 months of the year, but some bond ETF have flourished. [Don't Fear the Fed With These Bond ETFs]

The SPDR Barclays Convertible Securities ETF (NYSEArca:CWB) is a prime example, and although 10-year Treasury yields are lower by almost 1% Monday, it appears to be just a matter of time before the 3% level is broken to the upside with many market observers expecting further downside for Treasuries from there.

Soaring yields and taper speculation have proven to be boons for CWB as convertible bonds have historically been one corner of the bond market that thrives in rising rate environments.

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. [Convert to Convertibles]

Accounting for distributions, CWB is up almost 20% this year, making it the best-performing bond ETF. The fund has soundly thumped well-known bond ETFs such as the Vanguard Total Bond Market ETF (BND) , the Vanguard Short-Term Bond ETF (BSV) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) .

While convertibles are attractive rising rates options, they are not perfect. “Generally only lower rated companies issue convertible debt, so you have to live with a higher level of default risk. Yes, convertible bonds offer the best of both worlds… so long as the issuer doesn’t default,” writes David Merkel.

Still, CWB is does not really resemble a true junk bond ETF in either yield or credit quality. CWB’s 30-day SEC yield is 1.82%, or about 115 basis points below 10-year Treasuries. About 36% of the ETF’s holdings are rated A and Baa while 37.2% are rated below Baa and 27.3% are not rated, according to State Street data .

A combined two-thirds of CWB’s sector weight goes to technology, consumer non-cyclical and financial services.  Top-10 holdings include issues from Wells-Fargo (WFC), Bank of America (BAC) and Gilead Sciences (GILD).

SPDR Barclays Convertible Securities ETF

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CWB

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