The Federal Reserve is likely to raise interest rates this month, and many fixed income investors are concerned about that now-telegraphed move, but it pays to remember that not all bonds suffer as the Fed tightens.
For example, convertible bonds have an established history of proving durable against the backdrop of rising rates. That’s likely due to the asset class’s equity-like traits, and it’s a reminder that investors might want to consider the related exchange traded funds, including the American Century Quality Convertible Securities ETF (QCON).
“Convertible bonds are a form of hybrid security that companies issue as debt that investors can later exchange for equity if the business grows and the stock value goes up. The bonds are an especially viable option for companies, like many tech startups, that face short-term financing challenges but have strong growth prospects,” reports Ted Knutson for CFO Dive.
Owing to the fact that convertibles can be later converted to equity by the bondholder, these bonds are often deployed as capital-raising tools by young growth companies that want to avoid burdensome interest payments.
However, there are risks in that approach for issuers and investors alike. As just one example of a youthful company that is trading well below the convert price it offered to investors, DraftKings sold $1.3 billion in convertible debt last year. Bondholders have the option to convert to equity at a price of $70 — more than quadruple where the shares currently reside — in 2028.
Fortunately, QCON is actively managed and employs quality and value screens when building the portfolio. The ETF’s top 10 holdings are chock-full of convertible debt issued by mature companies, such as Broadcom (NASDAQ:AVGO), Palo Alto Networks (NASDAQ:PANW), and KKR (NYSE:KKR), among others.
There’s another benefit to QCON’s status as an actively managed fund. Many convertible issuers haven’t issued traditional corporate debt, aren’t yet rated by a major ratings agency, or both.
“Because non-rated issues make up a significant percentage of the global convertible market, with many companies foregoing ratings to avoid the length and expense of the process, it’s mainly sophisticated investors who get involved in the market,” according to CFO Dive.
With QCON, investors can get protection from strained convertible issuers with a fund that’s handily beaten the ICE BofA Convertible Index over the past year. QCON, which is 13 months old, charges 0.32% per year, or $32 on a $10,000 investment.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
