With interest rates set to rise this year, likely multiple times, some fixed income investors are pondering where to turn. For bond investors, the good news is that not all corners of the fixed income universe lag when the Federal Reserve tightens rates.
Just look at convertible bonds, which historically outperform other fixed income assets during Fed tightening regimes. Several exchange traded funds provide exposure to convertibles, including the American Century Quality Convertible Securities ETF (QCON).
“When you buy a convertible bond, it starts out working just like any fixed income security. As with most bonds, par value—the face value of the bond—is usually $1,000. The issuing company pays interest on the bond, which is called the coupon rate. If a convertible bond with a par value of $1,000 has a 6% coupon, it pays 6% annually ($60) or 3% ($30) semi-annually,” reports Forbes Advisor.
However, that’s not the end of the convertible story. These bonds are known as hybrid securities, meaning that they posses both equity and fixed income traits. To that end, QCON is all the more pertinent in the convertible conversation because it’s an actively managed fund.
As an active ETF, QCON offers investors the potential for a higher quality line-up of convertibles and the possibility of outperformance relative to passively managed rivals. How QCON can do that is also important to investors.
“Portfolio managers identify high-quality, growth-oriented names through both fundamental and quantitative analysis,” according to American Century. “Portfolio construction seeks optimal risk balance among securities offering attractive structural features and relative valuation.”
QCON’s ability to weigh both opportunity and risks is important in the convertible arena because there are times when shares of the underlying issuer are high compared to the conversion — meaning that the bonds will behave more like stocks. Conversely, there are also times when an issuer’s share price is low compared to the conversion, meaning that the convertibles will act more like bonds.
“Convertible bonds are issued with a conversion ratio, which is the number of common shares the investor will receive if the issuer chooses to exercise the conversion option. For example, a single bond with a conversion ratio of 10:1 can be converted into 10 shares of stock,” according to Forbes.
Getting back to QCON’s utility in a rising rates environment, convertible bonds usually sport lower interest rates than traditional fixed rate corporate debt, making convertibles less sensitive to Fed tightening. QCON, which turns a year old later this month, 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.