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Time for the Convertible Bond ETF?

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Given the current ultra-low yield environment and fears of interest rate hikes later this year or next, investors are searching for a safe and higher level of income with lower downside risk. One such area is the convertible bonds space which provides investors with some of the benefits of bonds as well as stocks.

What are Convertible Bonds?

Convertible bonds are those that can be exchanged at the option of the holder, for a specific number of preferred or common shares.

Like traditional bonds, convertible bonds are issued at 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 (read: Time for Inverse Bond ETFs?).

The price of these bonds generally moves in-line with the underlying shares. However, unlike shares, convertible bonds have some downside protection since 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 higher claim than the common shareholders on the company’s assets. This suggests that convertible bond holders could do better than their equity counterparts in such a situation.

Convertible Bond ETF in Focus

Investors seeking capital appreciation with a steady flow of income and lower downside risk can play with the only pure option in the space — SPDR Barclays Capital Convertible Securities ETF (CWB). The fund tracks the Barclays U.S. Convertible Bond > $500MM Index, before fees and expenses.

The ETF holds 99 securities with average maturity of 10.28 years. The product is quite spread out across individuals as it puts just 27% of the assets in the top 10 holdings. Securities from Wells Fargo (WFC), General Motors (GM) and Bank of America (BAC) occupy the top three positions in the basket.

The fund has heavy investments in the technology sector while consumer non-cyclical and finance occupy the next two spots (read: Three Tech ETFs Still Going Strong).

The product is heavily tilted towards intermediate term securities as those that mature in 5 years and before account for roughly 63% of the assets. In terms of credit quality, the fund has a tilt towards low quality bonds, as Baa and lower rated securities account for 88% of the assets (see more in the Zacks ETF Center).

CWB charges 40 bps in fees a year from investors. In addition, it trades in a good volume of more than 250,000 shares per day, ensuring a relatively tight bid/ask spread. Further, the fund gathered over $116.0 million in assets in the first quarter of the year, reaching $1.1 billion in AUM since its inception in April 2009.

In terms of performance, investors should note that the product has shown resilience, with an upward trend in the second half of the last year. This positive trend has followed well into 2013, with a more than 4% gain year-to-date.

The fund pays a solid 3.02% in annual dividend yield and 2.13% in 30-day SEC yield. While these yields may be lower than the traditional bond counterparts, it is higher than the dividend yield of the underlying common stocks (read: Two Unconventional Sources of ETF Yield).

Further, CWB has outpaced traditional bond counterparts by wide margins but underperformed broad equity ETFs (such as (SPY - Free Report) . This suggests that the ETF could be an interesting pick for investors seeking exposure to the fixed income market, while still partaking in a bit of the equity rally.

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