With the Fed expected to hike rates multiple times this year and the first one of those likely to hit the market as soon as in March, it is necessary to look for some ETFs which are less-vulnerable to rate rises but offer decent level yields.
At the same time, investors can take advantage of growing economy, corporate wellbeing and a decent equity market. But finding a better option other than convertible bond ETFs that can serve all these factors in one product is a tall order.
Investors must be happy to know that the U.S. economy last year grew at its fastest pace since 1984. Though the broader market has been wavering since the start of 2022 due to rising rate worries, the S&P 500 is currently just 6.6% off from its all-time high. Meanwhile, the U.S. benchmark treasury bond yields touched 1.96% on Feb 8, 2022.
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.
Why the Instrument May Be Useful Now
Convertible bonds are 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 no matter how the Fed acts, potentially making convertible bond ETFs solid picks for investors seeking a solid combination of fixed income and equity in their portfolios.
Investors should also note that the markets have also been pricing now the Fed rate hike moves. Hence, when the actual step will be taken, market reactions will not be that wild.
Choices are very few in this corner of the ETF world. The options are
SPDR Barclays Capital Convertible Bond ETF ( CWB Quick Quote CWB - Free Report) , 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).
However, with CWB and FCVT yielding minutely about 2.18% and 1.91%, respectively, we believe
iShares Convertible Bond ETF ( ICVT Quick Quote ICVT - Free Report) (which yields 3.67%) appears to be a better bet. The fund ICVT is up 0.5% past week but down 6.8% in the year-to-date frame.