Is Time Ripe For The Convertible Bond ETF?
The economy is on the threshold of an interest rate hike, a decade after a rock-bottom interest rate environment. Naturally, investors apprehend a sea of change and are looking for a safe and higher level of income with lower downside risk. After all, a December rate hike is now an extremely ripe prospect following a solid U.S. job report for October and the Fed’s perception that the U.S. economy is ‘ performing well ‘. Yields on the benchmark 10-year Treasury notes were at 2.32% on November 10, up from 2.05% recorded on October 27. Futures show a 68% chance of a lift-off by year-end compared with a 50% bet at October end. No wonder, investors have started to position their portfolio according to the looming lift-off and demand a high-yield but a harmless bet. For those investors, convertible bonds appear lucrative bets as these provide some of the benefits of bonds as well as stocks. What are Convertible Bonds? Convertible bonds are those that can be exchanged if the holder chooses to, for a specific number of preferred or common shares if the company’s share price climbs past a said conversion price during the bond’s tenure. Like traditional bonds, convertible bonds are issued on par, pay fixed coupons and have fixed maturities. The main difference is that convertible bonds offer investors the right to convert their bond holdings into a company’s shares at the holder’s discretion. This allows investors the potential to play both sides of a company – debt and equity – in a single security, offering a lower risk choice. The lack in this arrangement is that investors are compelled to accept a far lower coupon payment than traditional bonds of the same company. On the other hand, these bonds are less risky than equities. In case of bankruptcy, convertible bond holders get paid out ahead of equity holders. The price of these bonds generally moves in line with the underlying shares. However, unlike shares, the convertible bonds have some coverage against downside risks as investors can redeem these on par upon maturity, if the issuer is in business. All in all, these bonds are great instruments to tap a towering stock market, minimize risks and enjoy strong current income. ETF Impact Choices are very few in this corner of the ETF world. There is only one pure-play in the convertible bonds section – SPDR Barclays Capital Convertible Securities ETF (NYSEARCA: CWB ). Quite expectedly, the macro backdrop led to some decent trading in CWB in the recent past. CWB in Focus 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 toward the large cap securities. In terms of sector exposure, the product is skewed toward the tech industry (44.4%), while consumer staples and financial companies comprise about 16.6% and 12.4% of the portfolio. For credit quality, over 38% of the portfolio has a less than Baa rating, and over 35% of the basket is not rated followed by 19.2% having a Baa rating. The fund is also spread out in terms of maturities, with close to half of the bonds maturing in less than five years. This $2.73 billion-fund holds 104 securities. The top three holdings include Watson Pharmaceuticals 5.5 12/31/2049 (4.65%), Wells Fargo & Company (NYSE: WFC ) 7.5 12/31/2049 (4.27%) and Fiat Chrysler Automobile (NYSE: FCAU ) 787.5 12/15/2016 (3.24%). The fund was up 0.5% in the last one month (as of November 11, 2015) and yields about 4.61% as of the same date. Original Post