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Wednesday, Oct 4, 2023

Convertible Bonds Have a Mixed Reputation

Dear George: It’s been suggested that I invest in some convertible bonds. However, I have absolutely no idea what they are and how they work. Any suggestions?

, Glen, Escondido

Dear Glen: They say that a camel is a horse designed by a committee. Well, convertible bonds are the equivalent of a camel. On paper, convertible bonds seem to be a good idea; unfortunately, in reality, they never seem to work very well.

The concept is simple: create an investment that offers the benefits and features of both a stock and a bond. In its basic form a convertible is a bond. It has a fixed rate of interest and a specific maturity. Investors receive semi-annual interest payments.

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However, the real sizzle of a convertible bond is its potential ability to benefit from the potential growth of the stock of the underlying company. What you wind up with is a bond that has the ability to deliver a competitive rate of interest and the potential for capital gains.

The concept is certainly attractive but the performance has been less than overwhelming. The main reason that convertible securities have never captured the imagination of the investment community is because they are so darned complicated. No two issues are the same and you practically have to be an MBA to figure out one issue from another.

As is often the case when investments get confusing, perhaps the best way to approach convertibles is through a mutual fund. This gives you the advantage of hiring a professional manager who has the skills and tools to screen different bond issues and find the best investments. You also wind up with a diversified portfolio of convertible bond holdings.

The Vanguard Convertible Securities Fund is a good example. The fund owns 80 different bonds representing companies such as America Online, Cox Communications, and Global Crossing. The average maturity in the portfolio is a comfortable 5.2 years.

The 1999 performance of the fund certainly represented the equity side of the equation. The total return was a respectable 30.36 percent. However, over the past 10 years the performance has leaned more toward the bond side, still a respectable 12.45 percent.

The way an investor benefits from the convertible concept is through appreciation if the underlying stock goes up. The value of the bond will represent that increase. However, if the stock doesn’t go up the worse case scenario is that you get your money back when the issue matures.

I can see a convertible bond fund fitting nicely into a conservative portfolio, especially in a retirement account.

Dear George: I notice a lot of attention is being paid to the earnings reports that have been coming out in January. I thought earnings didn’t matter any more.

, Jerry, San Diego

Dear Jerry: Trust me, earnings still count. It’s price/earnings ratios that don’t have the same clout that they used to.

The earnings are a valuable measure of a company’s progress. Growth in earnings, sales, profits and just about every other measurable indicator will be inspected closely by analysts and investors. And, in this critical time, a company better do more than just meet expectations.

However, the price/earnings ratio just doesn’t draw much investor attention these days. It wasn’t that many years ago that investors stayed away from companies that had a P/E of higher than 10. Today investors are pumping millions of dollars into companies that have yet to report any earnings at all, meaning that there is no way to calculate a P/E ratio.

Like any other number, a price/earnings ratio is only useful when it is used as a comparative. If an entire industry has a high P/E, then you should not be scared off by a high number. However, investors are wise to be cautious whenever a company’s numbers vary widely from the industry average.

Chamberlin is the host of “Money in the Morning,” heard weekdays from 9 a.m. to noon on Ksdo.com A/M 1130. Send your letters to him to P.O. Box 1969, Carlsbad, CA 92018, or E-mail him at (george@,moneyinthemorning.com).


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