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Convertible Bond ETFs: A Pandemic Winner

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The volume of convertible bond sales has reached its highest levels since 2007 this year as companies scrambled to raise cash to fight the coronavirus-led economic slowdown. About $89 billion of convertible bonds have been issued in 2020, according to Refinitiv data. The boom has mostly been noticed in the United States, although European issuance is also growing.

This is exactly the opposite of the last financial crisis in 2008 when the convertible bonds market was hard hit, per Reuters. The global Thomson Reuters Convertible Index more than halved between May 2008 and March 2009. But this year, the Thomson Reuters global U.S. dollar convertible bond index rebounded quickly from the March market catastrophe and is now trading at a 2020 high.

What Are Convertible Bonds?

Convertible bonds are those that can be exchanged if the holder chooses to, for a specific number of preferred or common shares if the company's share price climbs past a said conversion price during the bond's tenure.

Like traditional bonds, convertible bonds are issued on par, pay fixed coupons and have fixed maturities. The main difference is that convertible bonds offer investors the right to convert their bond holdings into a company’s shares at the holder’s discretion.

This allows investors the potential to play both sides of a company — debt and equity — in a single security, offering a lower risk choice. The lack in this arrangement is that investors are compelled to accept a far lower coupon payment than traditional bonds of the same company.

On the other hand, these bonds are less risky than equities. In case of bankruptcy, convertible bond holders get paid out ahead of equity holders. The price of these bonds generally moves in-line with the underlying shares. However, unlike shares, the convertible bonds have some coverage against downside risks as investors can redeem these on par upon maturity, if the issuer is in business.

How the Instrument Has Become a COVID Winner

The record-low interest rates in the United States and the Eurozone have kept the bond investing charged-up in any case this year. Moreover, low levels of interest rates and the Fed’s promise of buying corporate bonds have boosted the stock market in the second quarter too (read: S&P 500's Best Q2 Ever: Stock & ETF Winners).

This scenario made these convertible bonds great instruments to tap a towering stock market, minimize risks and enjoy strong current income. In short, with the broader economy finally finding its footing (as evident from the recent data points), stock markets are expected to hold steady this year, potentially making convertible bond ETFs solid picks for investors seeking a solid combination of fixed income and equity in their portfolios.

ETF Impact

Choices are very few in this corner of the ETF world. The options are SPDR Barclays Capital Convertible Bond ETF (CWB - Free Report) , iShares Convertible Bond ETF (ICVT - Free Report) and First Trust SSI Strategic Convertible Securities ETF (FCVT - Free Report) (read: Convertibles/CEFs/Preferred Stock ETFs).

So far this year (as of Jul 7, 2020), CWB (yields 2.74%) has gained about 13.6% while PIMCO Active Bond ETF (BOND - Free Report) (yields 3.05%) has added about 5.1% and iShares 20+ Year Treasury Bond ETF TLT) (yields 1.72%) has jumped 22.3%. On the other hand, the SPDR S&P 500 ETF (SPY - Free Report) is still off 1.5% this year.

In the past three-month frame, CWB surged 30.1% while SPY advanced 18.9%. However, TLT was off 0.3% and BOND gained just 4.6%.  

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