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The Value Line Convertibles objective group covers mutual funds that invest in an unusual and relatively obscure asset class—convertible bonds and convertible preferred stocks.  Indeed, convertibles are a mixture of a bond (or a preferred stock) and a warrant to purchase common stock in the issuing company. This creates a hybrid security with both bond-like and equity-like features.

At times, a convertible bond can trade like a regular bond, based on the underlying company’s ability to make interest payments, interest rates, and other bond-specific factors. At other times, however, convertibles can trade more like stocks—typically when the value of the conversion feature (the warrant) is greater than the value of the bond. The end result is that convertibles often provide downside protection because of the bond component of the securities, but also upside participation if the stock price of the issuing company rises (though this participation is usually muted relative to a direct equity purchase). Investors interested in more information about convertibles should visit the Education page of The Value Line Convertible Survey.

Mutual funds are one of the best ways for individual investors to participate in the convertible market because of the illiquid nature of many convertible securities.  Also, small sales and purchases are often subject to large markups and trading costs, further reducing the benefit of direct purchase. Indeed, it would be difficult for an individual investor to cost effectively acquire a diversified convertible portfolio at competitive prices.

The convertibles market is small relative to the bond market and the stock market.  Moreover, many issuing companies in this space are financially weak compared to the broader markets. Thus, managers here are generally selective in their portfolio construction.  At the end of the day, the funds can be rather eclectic, and each needs to be reviewed carefully. Some managers tend toward more-aggressive, lower-quality holdings, while others prefer higher-quality investments. And these tendencies are subject to change based on market conditions.

Over the long term, the Convertible objective group has been a decent performer relative to the broader market, as measured by the Barclays Aggregate Bond Index.  For the 10-year period ended February 29, 2012, the group had an annualized return of 5.7%, while the Barclays Aggregate Bond Index reported an annualized gain of 5.6%. Over the trailing five- and three-year periods through February 29, 2012, the group had a gain of 3.3% and 19.7%, respectively, while the Index reported annualized gains of 6.2% and 7.5%, respectively. During the past year, the Convertible objective group reported a weak return of negative 2.6%, compared with positive 8.4% for the Index. By contrast, year to date through February 29, 2012, the Convertible objective group outperformed the Barclays Aggregate Bond Index. It reported a gain of 8.1% compared with a gain of 0.9% for the Index.

The group has a better-than-average Risk Rank of 2, indicating that funds in this group might appeal to more conservative investors. 


One fund with a relatively good year-to-date return through February 29, 2012 is Putnam Convertible Income-Growth Fund (PCONX).  This fund seeks current income and capital appreciation with equal emphasis. Its secondary objective is conservation of capital.

Under normal circumstances, the fund invests mainly in the convertible securities of U.S. companies. As of September 30, 2011, the fund’s holdings of foreign securities was less than 5% of net assets. The fund uses a bottom-up research process to identify both industries and companies. It invests in both below-investment-grade as well as investment-grade convertible securities. The convertible bonds purchased often have intermediate- to long-term stated maturities of three years or longer. PCONX’s active management style has helped it to purchase convertible securities in more-promising industries. Its turnover rate was recently 79% for the year ended October 31, 2011.

Another fund with a very good year-to-date return through February 29, 2012 is Vanguard Convertible Securities Fund (VCVSX). Its primary objective is to generate current income and long-term capital appreciation. This fund normally invests at least 80% of its net assets in U.S. and foreign convertible securities. Its team of analysts uses a bottom-up investment approach to select convertibles considered to have the best balance of upside potential and downside protection. When a convertible no longer has that balance —often because its price has risen— it becomes a candidate for sale. As of September 30, 2011, U.S. securities accounted for about 41% of total assets; Japanese for 48%; other foreign, 9%; and about 2% in cash. 

A third fund with a relatively good year-to-date return through February 29th is Invesco Convertible Securities Fund (CNSAX). This fund seeks a high level of total return through a combination of current income and capital appreciation. The fund pursues this objective by investing at least 80% of its assets in convertible securities. The remaining 20% may be invested in common stocks directly, non-convertible fixed-income securities, and foreign securities. Fixed-income investments include zero-coupon bonds and real estate investment trusts. The fund can allocate up to 10% of its net assets in foreign securities. It uses foreign currency exchange contracts as a hedge against exchange rates.

In the table below, we have listed 10 top-performing funds through February 29, 2012 that we follow in our Fund Advisor database.

 10 Top Convertible Funds Performance

 

Fund Name

Ticker

% Year-to-date

Total Return

% 1 Month

Total

Return

% 3

Month

Total

Return

% 6 Month

Total

Return

% 5 Year

Total

Return

Annualized

Fidelity Convertible

FCVSX

11.43

3.25

12.14

9.63

3.74

Columbia Convertible A

PACIX

9.66

3.17

10.78

8.60

2.78

Franklin Convertible Securities A

FISCX

8.83

3.27

9.52

8.22

3.32

Putnam Convertible Income-Growth A

PCONX

8.94

2.78

8.96

6.70

3.07

Allianz AGIC Convertible A

ANZAX

8.78

3.30

8.95

10.81

 

Vanguard Convertible

VCVSX

8.70

2.96

8.07

5.66

5.00

Lord Abbett Convertible A

LACFX

8.68

3.34

9.04

6.11

2.57

MainStay Convertible A

MCOAX

8.51

2.96

8.56

7.91

5.52

Invesco Convertible A

CNSAX

8.41

3.14

9.09

7.37

5.55

PIMCO Convertible A

PACNX

7.81

2.35

7.39

6.93

8.71

Convertible  Objective Group

  

8.09

2.79

7.65

6.65

3.35

  

  

At the time of this report's issuance, the author did not have positions in any of the funds mentioned.