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Convertible Bond ETFs Head-To-Head

Eric Dutram

With the rise of the ETF industry over the past few years, products have spread out into asset classes and sectors that were once off-limits to the average investor. Emerging market stocks, commodities, and currencies have been among the most popular, but other, more obscure parts of the investing world now have ETF representation as well. One of the most interesting is arguably the convertible bond space and the two exchange-traded products that track this market.

Convertible Bonds Explained

Convertibles are much like traditional bonds in that both have face values, coupon payments and maturity dates, but the similarities often end after that.  The main difference is that convertible bonds offer investors the right to ‘convert’ their bond holdings into a set number of stock shares once prices hit a certain ‘conversion’ level. This allows investors the potential to play both sides of a company—debt and equity—in a single security offering a lower risk option to some. The main downside is that investors are forced to accept a far lower coupon payment than traditional bonds of the same company. This can be especially troublesome in today’s low yield environment and could potentially push investors out of these securities for the time being (Top Three High Yield Junk Bond ETFs).

While the yield may be lower, convertibles still offer some nice advantages for investors. These securities allow investors to bet on a stock with much lower levels of risk than holding the equity outright. That is because if a firm were to go bankrupt, the bond holders would be paid out ahead of those that had an equity stake, suggesting that convertible bond holders could do better than their equity counterparts in this type of situation.

Furthermore, if the stock is muddling around below the conversion price, investors have the ability to obtain coupon payments which are often times far higher than the company’s dividend yield. This extra income can help convertibles to outperform equities when the stock price is flat but the convertible nature can allow them to outperform bonds if the stock surges, suggesting that these types of securities could be beneficial in both types of environments (see Australia Bond ETF Showdown: AUNZ vs. AUD).

Unfortunately, the market is pretty closed-off from the average investor making broad allocations to the space impractical for most. Luckily, a couple of ETF issuers have stepped up to the plate in order to offer up exposure to the industry in basket-form. Currently, two products exist targeting the market, and while they have several similarities, there are a number of key differences that investors should be aware of before choosing either for their portfolio:

SPDR Barlcays Capital Convertible Bond ETF (NYSEArca:CWB - News)

This popular ETF seeks to provide investment results that correspond generally to the price and yield performance of the Barclays Capital U.S. Convertible Bond > $500MM Index. This benchmark tracks United States convertible bonds with outstanding issue sizes greater than $500 million, giving the product a tilt towards large cap securities (read Do You Need A Floating Rate Bond ETF?).

In terms of sector exposure, the product is skewed towards the tech industry (29.4%), while financial and consumer staples companies both comprised about 17% of the portfolio as well. For credit quality, roughly half the portfolio is rated Baa or higher although 31% is rated below that figure and an additional 26% are not rated. The fund is also spread out around maturities with close to half the bonds maturing in less than five years. CWB has had a roughly 2011 as the ETF has tumbled by about 15.1% since the start of the year. Fortunately, the product’s 5.8% 30 Day SEC yield is quite high and is likely to soften the blow for many investors.

PowerShares Convertible Securities Portfolio (NYSEArca:CVRT - News)

The upstart in the space, having debuted in May of 2011, is this fund from PowerShares. CVRT tracks a similar index to CWB following the BofA Merrill Lynch All U.S. Convertibles Index in order to obtain exposure to the asset class. This benchmark is designed to track the performance of U.S. dollar-denominated investment grade and non-investment grade convertible securities sold into the U.S. market and publicly traded in the United States. The product currently holds 56 securities in its basket and charges investors an ultra low expense ratio of 35 basis points (see German Bond ETFs In Focus).

The fund also has somewhat of a tilt towards large cap firms with convertible bonds from Wells Fargo, Amgen, and GM all coming in the top five. Overall, the bonds are generally of high quality as well; close to one-fourth of the assets are rated A or higher by S&P while 14% are rated B or lower (although it should be noted that 27% are not rated at all). Maturity levels are skewed to the edges of the curve as close to half the portfolio matures in five years while another 15% comes due no earlier than 25 years from now. CVRT hasn’t been around all year so it is tough to compare its performance to CWB in the time period. However, when looking at the previous six months, the fund slightly underperformed CWV losing about 150 basis points more in the time frame.





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