Time May Be Right For Convertibles

In today's global economy, the stock market seems to be in a permanently volatile state. Many recommend diversifying your investments between stocks and bonds with a variety of characteristics. Yet the diversification many would recommend can result in mediocre returns.

Convertible securities, which are commonly known as convertibles, may provide a better alternative. Convertibles are typically issued as bonds or preferred stocks that can be converted to common stocks. They provide an ongoing stream of income, like bonds, but also have the potential for growth based on the option to convert into the underlying stocks.

Most investors do not convert their convertibles. Even in their bond form, their value will fluctuate based on the underlying stock (although typically not as much as the stock). By holding the convertible long-term without converting it to stock, the owner of the convertible continues to earn income and take advantage of growth in the common stock.

Convertibles are especially good for investors who are heavily invested in either stocks or bonds.

Convertibles vs. Bonds

Many investors are risk averse because their number one goal is preserving wealth, rather than increasing it. Such investors, who are typically retired or nearing retirement, often invest the bulk of their portfolio in bonds and other fixed-income securities.

However, bonds have not performed well recently. While 10-year Treasury bonds are the safest security available, they can provide negative total returns when interest rates rise. In an attempt to be cautious, bond investors may lose money as inflation erodes their purchasing power over the long term.

Convertibles vs. Stocks

Even more investors, especially those seeking to continue accumulating wealth, are heavily invested in stocks. They, likewise, have experienced increasing price volatility recently. Returns have been inconsistent.

Stock investors are seeking growth, but, like bond investors, could lose money if the market performs poorly. Rising interest rates, terrorist attacks, inflation and many other factors can cause the market to perform poorly.

Consider convertibles vs. stocks in more detail: Convertibles offer less volatility. They go up in value when the underlying stock increases in value and they go down in value when the underlying stock decreases in value. The difference is that convertibles don't go up or down in value as much as stocks do. And, in either case, they also provide income.

Why Convertibles?

Given the volatility of the stock market and the generally poor performance of the bond market, convertibles offer investors the best potential opportunity to stabilize their portfolio.

Convertibles can provide investors with the benefits of both stocks and bonds:

• For investors whose portfolio is heavy with bonds, convertibles continue to provide income, but add exposure to growth as a hedge against inflation.
• For investors whose portfolio is heavy with stocks, convertibles can add income and reduce portfolio volatility.

In other words, convertibles provide growth, income and downside protection. Should the stock market drop in value, convertible values should drop less. In addition, income from the convertibles will offset some of the drop. Should the stock market increase in value, investors in convertibles will benefit; realizing an equity-like total return from the combination of the convertible's price appreciation and its income.

About Cutler Capital Management

Cutler Capital Management of Worcester, Mass. (www.cutlercapital.com) is an investment management firm specializing in investing in convertible securities, real estate investment trusts (REITs) and dividend-paying bank stocks to provide growth and income to high-net-worth investors, and charitable foundations and other non-profit organizations. Founder Melvin S. Cutler has researched and invested in securities since 1975 and currently manages more than $245 million in assets.

Cutler Capital currently manages two private investment funds to meet the differing investment goals, tolerance for risk and investment timelines of our clients. In each case, capital from like-minded investors is pooled and invested in a diversified group of convertible securities, REITs and dividend-paying bank stocks.

For performance information and other key features about Cutler's private investment funds please register here.