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Convertibles ETF on the Cheap After Stocks Fall

The recent swoon in stocks has sent investors scurrying into safe-haven assets such as the U.S. dollar and exchange traded funds that hold U.S. Treasuries.

Between Sept. 26 and Oct. 8, U.S. bond ETFs added $9.1 billion in new assets, according to BlackRock data. Last week, the PowerShares DB US Dollar Index Bullish Fund (UUP) hauled in $154.8 million in new assets. [Investors Flock to Dollar ETFs]

Conversely, weakness in stocks has hampered riskier fixed income genres with convertibles and high-yield debt getting pinched by sliding equities. However, that does not mean investors should forsake these once beloved corners of the bond market. In fact, the pullback in stocks may have created a buying opportunity in the SPDR Barclays Convertible Securities ETF (CWB) , particularly for investors betting that the Federal Reserve will hike interest rates sometime next year.

Elevated equity market volatility has forced credit spreads to widen, a thorn in the side of both junk bonds and convertibles. Although CWB’s 101 holdings are vulnerable to equity pullbacks because convertible bonds often display close correlations to stocks, the outlook for the ETF and broader convertibles market remains solid.

“The converts market continues to be driven by the underlying equities and we expect equities to do regain their footing,” said State Street Global Advisors Vice President and head of research Dave Mazza in an email to ETF Trends. “In addition, SSgA’s positive outlook for US economic growth is supportive of high yield as spreads have historically remained low during period of strong economic growth.”

Convertible bonds can be looked at 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. [Calling on Convertibles]

CWB has risen in popularity as more investors have learned two important traits about the ETF and the convertibles market. First, convertible bonds have been the best-performing fixed income asset class in prior rising rate environments. Second, as Mazza notes “CWB’s expense ratio of 40 basis points is far below the 112 basis points median expense ratio of the funds in the Morningstar Convertibles universe.”