Convertible Securities

• Advantages
• How They Work

By generating regular income, they provide a level of protection against losing money if stock values decrease, along with the ability to benefit from growth if stock values increase.

Advantages
Why should you invest in convertibles? They offer the following advantages:

High current income: Convertible securities typically provide high current income in relation to the underlying common stock, regardless of whether the price of the stock rises or falls.

Equity participation: If the value of the common stock rises, the value of the convertible often does, too, which helps the convertible outperform a straight bond.

Downside protection: In a down market, convertibles typically decline, at most, to the level of their value as a fixed-income investment, which helps them outperform ordinary stocks during a down market.

Total return: Past performance demonstrates that a satisfactory risk/reward return can be achieved by investing in convertible securities. Returns may be somewhat lower than for common stock, but the risk is considerably lower. Income adds to the total return.

A study by Ibbotson Associates shows that for the period 1973 to 2000, the total return for domestic convertibles approached that of the S&P 500 (11.89% vs. 12.97%) with significantly lower risk. In fact, the risk was comparable to that of long-term corporate bonds, which posted a return of 8.99% for the same period.

Generally, convertible securities have shown a closer correlation with both large- and small-cap stocks, and less correlation with fixed-income securities and other asset classes.

View Chart 5: Why should You Invest in Convertibles?

Convertibles provide investment in a broad mix of industry sectors with a wide range of credit quality. That creates diversification and the ability to meet varied investment objectives with favorable risk/reward characteristics over common stock.

For portfolios that are oriented toward bonds, the addition of convertibles will likely maintain income, but significantly increase the potential for growth. Overall risk will likely increase, but should remain below the level of risk created by investing in stock. Diversification will help reduce the risk.

For portfolios that are oriented toward stock, the addition of convertibles will likely reduce risk as measured by volatility, increase income and maintain the potential for growth.

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