Convertible Bond ETF Offers Equity Twist on Fixed Income

In a low interest rate environment, companies had little incentive to offer convertible bonds to raise cash because it was relatively cheap to access capital. 

Accessing capital is costly now after the Federal Reserve’s aggressive interest rate hikes, especially for small- and mid-cap companies with less creditworthiness. 

Matt Kaufman, head of exchange-traded funds at Calamos Investments, says as corporate borrowing costs have doubled in the past two years, nearing 8%, convertible bonds are becoming attractive financing tools again.  

Convertible Bonds' Features

Convertible bonds are corporate bonds with a conversion feature, a call option allowing bondholders to convert the bond into a fixed number of equity shares in the future. When share prices rise, convertible bonds trade more like the underlying stock price, but if share prices fall, the call option becomes out of the money, and starts to trade like a bond.  

Calamos Investments launched the rules-based, actively managed Calamos Convertible Equity Alternative ETF (CVRT) on Oct. 4. Kaufman says with $4 trillion in debt maturing in the investment-grade and high-yield fixed-income markets in the next few years, the convertible sector will likely see plenty of supply. Calamos is the largest U.S. convertibles manager, and this is its second exchange-traded fund.  

There are only a half-dozen convertible bond ETFs, and the largest two by assets under management are passively managed, the $3.4 billion SPDR Bloomberg Convertible Securities ETF (CWB) and the $1.3 billion iShares Convertible Bond ETF (ICVT). 

CVRT’s Variables 

A few variables make CVRT stand out from the two larger ETFs, Kaufman says. The passive funds are fixed-income heavy, while Calamos’ fund is designed to provide targeted exposure to more equity-sensitive part of the convertibles sector, selecting securities that trade more like stocks. 

To find those names, Calamos looks at a bond’s rate of change relative to an underlying stock’s price, known as delta. A convertible bond with a delta of 50 will move a 0.5% for every 1% the underlying stock price moves. The fund seeks bonds with a delta of 65. 

Calamos worked with ICE to custom-build an index to provide guidelines and benchmarking for the fund, but Kaufman says what gives CVRT an active edge is the firm will apply credit analysis and other bottom-up research to overweight or underweight names in the portfolio. Holding will be rebalanced monthly. The fund has a 0.69% expense ratio and in the first month has seen about $5 million in flows. 

As an equity-sensitive convertibles ETF, the fund sits in a portfolio’s equity sleeve as an alternative to an investor’s small- to mid-cap equities holdings, he says. It can also be a complement to other convertible bond holdings that are income focused. 

Shorter Maturities 

Peter C. Earle, an economist with the American Institute for Economic Research, says companies’ decisions to issue convertibles and the characteristics of the bonds issued hinges on the economic outlook. He also pointed out that most convertible bonds have shorter maturities, about five years or less.  

Earle agrees that the Fed rate hikes make convertibles a viable vehicle for financing, leading to a jump in issuance after a slow 2022. Plus, issuing firms are in better shape financially.  

“The current interest rate environment will tend to favor refinancing over recapitalization, and that should favor the number of convertible bonds coming into the market," Earle says. 

"On top of that, with more convertibles being sold, there's bound to be increased competition among issuers, and more liquidity in those issues—both of which are good for investors,” he says. “Coupons are at levels that beat inflation, and there's potential for equity upside.”