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Convertible Bond ETFs for Income With Growth Potential

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As a result of rapid expansion of the line-up of ETFs, the investors now have easy access to some of the products that were earlier suitable only for sophisticated investors, due to their complex structures or valuation challenges. (Read: Three Excellent Dividend ETFs for Safety and Income).

One such area where the regular investors were hesitant to invest earlier is convertible bonds space which provides the investors with some of the benefits of bonds as well as stocks.

What are Convertible Bonds?

Convertible Bonds are bonds that can be exchanged at the option of the holder, for a specific number of preferred or common shares. They combine the characteristics of bonds and equities.

Like traditional bonds, convertible bonds are issued at par, pay fixed coupons and have fixed maturities. The bonds can be redeemed at maturity or converted into company’s shares at holder’s discretion.

The price of these bonds generally moves in-line with the underlying shares. However unlike shares, the convertible bonds have some downside protection since the investors can redeem them at par on maturity as long as the issuer remains solvent. And in the event of bankruptcy, convertible bond holders have a prior claim than the common shareholders on the company’s assets.

As such, they are attractive for investors seeking capital appreciation with steady flow of income and lower downside risk. (Read: The Guide to International Treasury Bond ETF Investing)

In exchange for the option to convert the bonds and thus retain the upside potential, the investors settle for lower yield than traditional bonds. However the yield is usually higher than the dividend yield of the underlying stocks. (Read: Forget T-Bonds, Invest in These Top Corporate Bond ETFs)

There are currently two ETFs that provide exposure to convertible bonds.

SPDR Barclays Capital Convertible Securities ETF (CWB - Free Report)

CWB follows Barclays Capital U.S. Convertible Bond>$500 MM Index, which is designed to represent US convertible bonds with outstanding issue sizes greater than $500 million. Started in April 2009, the fund has gathered $784.04 million in AUM so far.

CWB holds 101 securities, with average maturity of 10.32 years. The fund is heavily invested in Technology sector (31%) while Finance (18%) and Consumer Non-cyclical occupy the next two spots.

The fund charges 40 basis points in expense per year and has a dividend yield of 3.41% currently. 41% of the holdings are rated Baa or higher.

CWB has returned 5.25% year-to-date. (Read: Emerging Markets Sovereign Bond ETFs: Safe With Attractive Yields)

PowerShares Convertible Securities Portfolio

CVRT follows BOA Merrill Lynch All U.S. Convertibles Index which is designed to track U.S. dollar denominated investment grade and non-investment grade securities. The ETF was launched in May last year and has managed to attract $9.2 million in assets so far.

The fund charges 36 basis points in expense per year and has a dividend yield of 3.15% currently. It holds 60 securities with 8.88 average years-to-maturity. The fund is rebalanced and reconstituted monthly.

Among the holdings, 20% of the securities are rated Baa or higher, while 68% are not rated.

CWB has returned 5.61% year-to-date.

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