Convertible bond exchange traded funds are a good way to reduce volatility in a fixed-income investment portfolio and generate some extra cash on the side.
Convertible bonds are a type of fixed-coupon security that allow the holder the option to swap the bond security for common or preferred stock at a specified strike price. Due to the bond’s equity option, convertible bonds typically pay less interest than traditional corporate bonds, but they are also a cheaper way for speculative-grade companies to raise capital. The fund, though, does not convert its holdings into shares, but investors are exposed to the equity premium due to the way the bonds are priced.
Additionally, within the capital hierarchy, convertibles are senior to equities but subordinate to traditional bond securities.
CWB’s credit quality breakdown includes a significant exposure to speculative, junk debt. Specifically, the ETF includes 34.5% in below Baa and 28.9% non-rated debt securities, along with investment-grade Baa 24.9%, A 9.1% and Aaa 2.6%.
“Despite the fund’s lower-quality holdings, its bond component actually gives it less volatility than the average large-cap equity fund, which can help it perform better during market downturns,” Boccellari added.
The ETF has a 1.93% 30-day SEC yield and a 0.40% expense ratio. CWB has increased 8.7% year-to-date. It has also outperformed junk and investment-grade corporate bonds so far this year. For example, the SPDR Barclays High Yield Bond ETF (JNK) is up 2.5% year-to-date while the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) is 6.5% higher. [October a Banner Month for Bond ETFs]
The fund provides a good middle ground between pure equities or fixed-income exposure. Convertibles typically perform well when the equities markets strengthen, which occur during a healthy economic environment. The securities are also less volatile than stocks since they would pay their full principal at maturity like a regular bond. [A Good Time to Take the Convertibles ETF for a Spin]
“It could be a good investment for investors willing to give up some of the equity upside to protect downside and increase their yield,” Boccellari said.
SPDR Barclays Convertible Securities ETF
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.
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.