The Case For Convertible Bond ETFs

August 31, 2017

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Gary Stringer, president and chief investment officer of Memphis, Tennessee-based Stringer Asser Management.

The U.S. stock market is at all-time highs, but one of the best ways to capture equity upside right now may instead be through convertible bonds.

As global equity markets appreciate and the business cycle advances, convertible bonds offer a diversified source of return and a compelling risk/reward trade-off.

The structure of convertible bonds allows them to participate in equity market upside, while presenting an attractive yield and less volatility risk than the global equity market.

Another benefit is that convertible bonds also have a relatively low correlation to traditional equities and bonds, which should prove beneficial if market volatility increases.

 

 

How It Works

Convertible bonds are hybrid securities, combining characteristics of equities and traditional bonds, as each convertible bond is exchangeable for equity shares. As equity prices move upward, the value of the convertible bond moves up to a degree based on its conversion feature. This can lead to a healthy amount of equity sensitivity as equities move higher.

However, as equities sell off, convertible bonds will fall. But they generally will find support on the downside as they begin to be valued for their fixed-income characteristics, such as the return of principal and interest payment. 

 

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