Convertible bonds: unique tools for income-generating investors
May 24, 2012
Convertible bonds are favorable hybrids, combining the characteristics of fixed income securities and equities. They are often out of the spotlight but, if appropriate, they can potentially play an opportunistic role within income-producing portfolios.
How can convertibles affect a portfolio’s risk orientation?
Convertible bonds typically exhibit risk/reward patterns that are favorable when compared to shares of their underlying stocks. Generally speaking, convertible bonds participate meaningfully when stock markets advance. On the other side of the coin, convertibles typically offer bond-like features when equities retreat: much of the time, convertibles fall less than common stocks, and they continue providing interest income even when common stocks continue performing weakly. Because of their hybrid features, convertibles could provide investors with positive equity exposure while offering meaningful potential to generate yield.
What is a convertible bond, and how does it work?
A convertible bond is a unique, two-faceted security. While bearing many of the same traits as conventional bonds (recurring coupon payments, for instance), a convertible bond offers a unique feature: it can be exchanged for shares of common stock.
A convertible bond is usually issued by a corporation, especially when other means of raising capital would be more expensive. To make the bond more attractive to investors, the issuer adds a conversion feature that allows bondholders to exchange the bond for a specific amount of the company’s stock. This right can typically be exercised any time before the bond reaches maturity.
Investors are reminded that convertible securities generally provide yields higher than the underlying stocks, but generally lower than comparable non-convertible securities, in exchange for limited upside potential.
If the convertible bond is callable, the issuer has a right to forcibly convert the bonds into shares of the company’s stock if the price of the stock is higher than the amount it would be if the bond were redeemed, or, at its call date, which caps the capital appreciation potential of the convertible bond.
At Delaware Investments, we approach convertible bonds deliberately and methodically, according to our assessment of broad market conditions. When evaluating a prospective convertible investment, we study its potential for income and appreciation, and we keep in mind any indications of undue risk.
The views expressed represent the Managers’ assessment of the market environment as of June 2012, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the manager's current views.
Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting our fund literature page or calling 800 362-7500. Investors should read the prospectuses and the summary prospectuses carefully before investing.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.