The Convertibles Come Calling: A Middle-Ground Bond ETF | ETF Trends

Convertible bonds are among this year’s best-performing fixed income assets. Investors can access convertibles without needing to fully commit with the Principal Spectrum Tax-Advantaged Dividend Active ETF (PQDI).

PQDI, which debuted in June, offers exposure to multiple income assets, including convertibles. The Principal ETF “seeks to provide current income. Under normal circumstances, the fund invests at least 80% of its net assets, plus any borrowings for investment purposes, in dividend-paying securities at the time of purchase,” according to Principal. “Such securities include, without limitation, preferred securities and capital securities of U.S. and non-U.S. issuers. The fund invests significantly in securities that, at the time of issuance, are eligible to pay dividends that qualify for favorable U.S. federal income tax treatment.”

PQDI offers a higher level of income because it combines convertibles exposure with preferred stocks and REITs, among other income-generating assets. PQDI’s convertibles allocation is proving potent this year.

PQDI YTD Performance

“Convertible securities are having an impressive 2020, with a major index up 36% through the end of November, making the hybrid securities one of the top-performing U.S. asset classes this year,” reports Andrew Bary for Barron’s.

Convertible Bonds Going Forward

Convertible bonds are a type of hybrid fixed-coupon security that allows the holder the option to swap the bond security for common or preferred stock at a specified strike price. Due to the bond’s equity option, convertible bonds typically pay less interest than traditional corporate bonds. The fund, though, does not convert its holdings into shares. Investors are exposed to the equity premium due to the way the bonds are priced.

Convertibles are outperforming other high-yield bonds this year.

“U.S. convertible issuance through November has totaled $96.6 billion, nearly double the $53 billion in all of 2019 and the highest issuance total since 2001,” according to Barron’s. “Convertible returns are the highest since 2009, and the market is easily topping the S&P 500 index, which was up 14% year-to-date through Monday and the junk-bond market, which has gained 4.2% through the end of November.”

Convertible bonds are seen as a middle ground between stocks and bonds. The securities pay lower coupons than regular unsecured debt securities, but they can also make up the difference if the company’s shares continue to appreciate.

New issuance isn’t denting demand and with rates low heading into 2021, PQDI’s convertibles exposure could serve the ETF well in the new year.

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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.