Not much is working in the bond market this year, and the same is certainly true of equities, so there’s no getting around the fact that hybrid securities are scuffling, too.
That’s the case with convertible bonds, which are perhaps the most equity-like bonds available. After all, convertible debt can be converted by bondholders into equity of the issuing company. Translation: It’s difficult for this asset class to generate upside when both stocks and bonds are flailing, but convertibles’ 2022 struggles could be opening the door to opportunity with exchange traded funds such as the American Century Quality Convertible Securities ETF (QCON).
“Convertible bonds typically offer lower yields than conventional bonds of similar duration from the same issuer, even though the convertibles may offer higher return potential over time due to their exchange features,” according to Fidelity research. “Convertibles also have greater price volatility. The volatility and return potential are driven by the value of the bond’s interest and redemption payments and the value of the equity option.”
With equities faltering this year, that volatility has been on display, but that turbulence also highlights the benefits of QCON being actively managed. That makes the fund stand out in a sparsely populated ETF segment dominated by passive funds.
Additionally, QCON’s status as an active fund means managers can take steps to reduce the portfolio’s overall sensitivity to rising interest rates — something index-based rivals cannot do.
“The bond portion’s value in a convertible tends to vary as conventional bonds would—with changes in market interest rates and perceived credit risk. The equity option’s value, on the other hand, may respond like shares of stock to changes in the company’s business performance, increasing or decreasing in value as profit prospects change,” added Fideltiy.
The point about credit quality is pertinent because many convertible issuers are junk-rated or reside at the lower end of investment-grade territory. Some credit-conscious investors are fretting about the specter of downgrades should a traditional recession arrive. However, even if that ominous scenario comes to pass, it could serve to underscore the benefits of QCON being actively managed because the fund can avoid potential credit trouble spots.
By emphasizing fundamental and quantitative analysis and high-quality issues, QCON could offer investors a prime avenue for positioning for a rebound by both stocks and bonds.
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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.