A perusal of Convertible Debt Funds - A Diversification tool for your portfolio.
For conservative investors and for investors looking to diversify their portfolios, convertible debt is a luring option to consider for investment into growth-oriented companies. A convertible debt security is a security that can be swapped for a specified amount of stock at the option of the issuer or borrower. They are less volatile instruments that carry features of both stocks and bonds. When the stock price of the company is on a rise, these instruments proffer excellent returns on investments, and when the stock price falls, they provision the security of consistent coupon payment returns.
With the stock markets at their propitious spell, companies are capitalizing on the fact and issuing low cost debt to fund their cash requirements. For example, General Motors recently announced that it would be raising $1.3 billion in unsecured convertible debt securities maturing June 1, 2009. In addition, Singapore based Capitaland latterly announced that it raised $654 million in Singapore’s largest convertible bond sale. More than $55 billion equity linked notes were sold in 2006, an increase of 35% since 2005. 13 companies raised greater than $1 billion in 2006.
Most convertible debt consists of multifarious terms and conditions, so investors prefer to invest through Mutual Funds. A convertible debt fund consists of a portfolio of convertible debt issued by various corporations. They all hold the option of converting the debt into stock at a specified price anytime, and pay fixed coupon interest payments in the meantime. The issuance of these convertible debt funds is on a rise now and is attracting a lot of hedge fund interest as well.
With the markets at their current strength, these funds have been performing very well, outpacing the returns from balanced funds. This is substantiated by the fact that the average annualized return from balanced fund in the past decade has been 7.1% vs 8.4% for a convertible bond fund. Balanced funds conventionally invest in high rated bonds and convertible debt issues invest in less credit worthy issues that command greater premium and give better returns during an expanding economic scenario. In most cases, these securities tend to bring in more income than traditional dividend paying options as well.
The caveat for investing in a convertible bond fund is that these securities often carry a call protection option. This implies that whenever the price tends to cross a specified level, the debt is converted into stock. This means that the lender has protection over the price that a security could demand. Furthermore, these securities carry a lower yield/ coupon than similar term nonconvertible bonds. However, these instruments could be considered to lend the much needed ‘spice’ to a conservative portfolio as well as lend diversification to a medium risk portfolio.