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Convertible Bonds: Income Securities With Positive Equity Exposure
by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Thursday, January 15, 2009: Issue #916
Editor’s Note: Over a week ago, Alexander Green recommended Oxford Club subscribers take a look at convertible bonds. They represent a way to hold income securities with some positive equity exposure. It fits in perfectly with our asset allocation portfolio, since we recommend 10% in high-yield bonds and 10% in high-grade bonds. We’ve excerpted his article because we feel there isn’t enough being said about these investment vehicles. Take a look…
Stocks are beginning to move again – the Dow rose over 6% last week alone – but many investors are skeptical of how long the rally will last. Already the market has pulled back.
As I describe in the January Communiqué, I believe this will be a good year for stocks despite the economic downturn.
But if you’re feeling a little gun shy after last year’s rollercoaster ride, there is a second-best alternative: convertible bonds.
Convertibles are corporate bonds that can be converted into shares of the issuing company. At the time a convertible is created, the company spells out exactly the number of shares that can be converted, the price at which the conversion can occur and the time frame.
Typically, convertible bonds have a lower coupon rate than ordinary bonds. But since the holder is given the right to convert the bond into common stock – often at a substantial discount to the shares’ current market value – they offer superior upside potential.
Convertible Bonds – More Conservative Than Stocks
Convertible bonds are more conservative than stocks because they represent a senior claim on the company and will pay interest even if the underlying stock doesn’t rise. And they are more aggressive than ordinary bonds because a drop in shares of the issuer can negatively affect them.
If the underlying stock rises, however, the bond will climb along with it. So, in essence, you have the safety of a bond combined with the appreciation potential of equities.
Like virtually every asset class (with the exception of Treasuries and gold bullion), convertible bonds had a tough year in 2008. Why? Both corporate bonds and common stocks fell sharply.
But convertible bonds now represent excellent value, especially for investors who are only tiptoeing back into the waters.
For this reason, you should consider buying or adding shares of convertible bonds to your investment portfolio.
Good investing,
Alex
Editor’s Note: Alex profiled his favorite convertible bond fund for Oxford Club members. For individuals seeking high yields combined with capital appreciation, this fund could be what you’re looking for. To get all of Alex’s recommendations and the Communiqué, sign up for The Oxford Club. Then check out the recent portfolio updates.
If you’re already a member, you can log in here.
Today’s Investment U Crib Sheet – Investing in Bonds: 2 More Ways
Alexander Green gave us the first “Obama Investment” way back in June. Well before the election was won, the experts at Investment U were already looking at ways to protect your capital, and increase your returns with the new administration. And with inauguration only days away, it’s time to revisit those opportunities. To find out more and get four ways to profit take a look at Investment U Issue #810, Municipal Bonds: “The First Obama Investment.”
Almost a year ago, Alex took a look at the benefits of “junk bond” investments. With the current credit crisis, numerous other bonds have been given “junk” status. But that doesn’t mean that we shouldn’t be reviewing them just as carefully. Take a look at Alex’s reasoning for holding junk bonds a year ago. Many of his arguments are just as true today. To find out more, check out Investment U Issue #727, Junk Bonds: Why One Man’s “Junk” Is Another Man’s Treasure.
Our senior analyst from the White Cap Report just released a breaking update to Investment U on an opportunity in oil with a situation called “contango.” Regardless of whether you’ve already heard about these unique (and fleeting) profit opportunities, we recommend you take a look. Read the full article – Contango: The Most Profitable “Buy-and-Hold” for 2009.
- What to Do When Interest Rates Rise
- Senior Secured Floating Rate Bonds: The Best Investments to Own When Interest Rates Rise
- Municipal Bonds: A True Once-in-a-Lifetime Opportunity
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Alexander Green is the Investment Director of The Oxford Club. A Wall Street veteran, he has over 20 years experience as a research analyst, investment advisor, financial writer and portfolio manager.
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