The volume of convertible bond sales has reached its
highest levels since 2007 this year as companies are scrambling to raise cash to fight the coronavirus-led economic slowdown. The boom has mostly been noticed in the United States, although European issuance is also growing.
We all know that the Nasdaq is skyrocketing this year due to its greater exposure to the in-demand technology sector. But convertible bonds are beating this soaring index too.
SPDR Bloomberg Barclays Convertible Securities ETF ( CWB Quick Quote CWB - Free Report) was up 7.1% past month versus gains of 6.6% and 5.1% in the Nasdaq and the S&P 500, respectively (read: Nasdaq-100 ETF Hits Record High: 5 Stocks Powering the Rally).
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 segment is soaring and the ETF CWB is siting at an all-time 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 potential chance to play both sides of a company — debt and equity — in a single security, offering a lower-risk choice. The drawback 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 them on par upon maturity, if the issuer is in business.
Why Convertible Bonds Are Surging?
The record-low interest rates in the United States and the Eurozone have kept bond investing charged up in any case this year. Moreover, low levels of interest rates and the Fed’s corporate bond buying have boosted the stock market from the second quarter too (read:
S&P 500's Best Q2 Ever: Stock & ETF Winners).
This scenario made the 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 portfolio.
Choices are not plenty in this corner of the ETF world. The options CWB,
iShares Convertible Bond ETF ( ICVT Quick Quote ICVT - Free Report) and First Trust SSI Strategic Convertible Securities ETF ( FCVT Quick Quote FCVT - Free Report) (read: Convertibles/CEFs/Preferred Stock ETFs).
So far this year (as of Aug 18, 2020), CWB (yields 2.50%) has gained about 22.5% while
PIMCO Active Bond ETF ( BOND Quick Quote BOND - Free Report) (yields 2.96%) has added about 4.3% and iShares 20+ Year Treasury Bond ETF ( TLT Quick Quote TLT - Free Report) (yields 1.67%) has jumped 21.7%.
Among the other convertible bond ETFs, ICVT is up 26.8% and FCVT has added 20.5%. Also,
SPDR S&P 500 ETF ( SPY Quick Quote SPY - Free Report) is still up 4.7% this year. Want key ETF info delivered straight to your inbox?
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