Investors, searching for safer havens, are pulling out of stocks and investing in bonds and government securities. Indeed, the Dow Jones Bond Average gained 0.8% in January, while our All Convertibles Total Return Index grew 1.8%. Even the government is considering the option of buying “convertible securities from financial institutions,” with bailout money (according to an article in the January 21st Wall Street Journal). Because of their hybrid nature, convertibles could be the ideal investment for investors “hooked” on stocks, as we go through this recession. A convertible has an investment value (a bond value); it pays income, which is generally higher than that of the stock; and the warrant portion gives holders a call option on the underlying stock when equity markets perk up again. And, they are more stable than stocks.
The exceptional leverage provided by warrants makes them ideal candidates for hedging. A warrant hedge consists of a long position in a warrant and a short position in the underlying common stock.
Convertibles are a niche investment that are, unfortunately, on the outskirts of most investors’ radar screens. A quick primer, however, might help change that.
Risk typically increases with potential return. There are, however, some investments that historically have provided larger than expected returns in proportion to the risk of the securities involved. Convertibles fall into this category.