I began investing in convertible securities during the 1970s, and since then, I’ve seen an exciting evolution of the asset class—from little-known securities to a global asset class totaling approximately $342 billion USD today, including issues from household-name companies worldwide. Clearly, what began as an “alternative investment” has become much more mainstream.
Despite this growth and broader acceptance, the different ways that convertibles can be used in asset allocation are less well understood. What’s important to remember is that convertibles can support multiple asset allocation goals because of their hybrid characteristics. Convertibles combine equity and fixed income attributes, but the balance changes over time—both for the convertible universe as a whole as well as for individual securities. That makes active management essential. You can’t reap the potential benefits of convertibles simply by including them in a portfolio. Instead, you need to find the right blend of convertibles and manage them to achieve a particular objective.
Because convertibles offer the opportunity for equity participation with potential protection from downside volatility, I’ve long advocated including them within a strategic (or core) allocation, held through full market cycles. (My paper, “The Case for Strategic Convertible Allocations.” explores this at greater length.) In my view, the benefits of using convertibles to pursue lower-volatility equity participation are particularly pronounced in the current market environment. As our team has discussed in other posts, this bull market has been volatile but we see continued upside. Because fixed income attributes may lessen the impact of equity market downside, convertibles can mitigate anxiety about short-term market fluctuations.
In addition to holding convertibles strategically through market cycles, I believe there’s good reason overweighting convertibles more tactically in the current environment, within what I like to call an “enhanced fixed income” allocation. An enhanced fixed income allocation seeks to further portfolio diversification—with less vulnerability to interest rates changes than traditional fixed income investments (government bonds and investment-grade corporate bonds). Increasingly, we’re speaking with institutional investors who are concerned about how an eventual rise in interest rates could hurt their fixed income investments. Convertibles have historically been less sensitive to interest rate risk because of their equity characteristics. This can make convertibles a compelling alternative to traditional fixed income securities—for institutional and individual investors alike.
Asset allocation and diversification do not guarantee a profit or protect against a loss. Past performance is no guarantee of future results. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
The information in this report should not be considered a recommendation to purchase or sell any particular security. The views and strategies described may not be suitable for all investors. Convertible securities entail credit risk and interest rate risk.
Convertible asset size data is as of February 28, 2015. Source: BofA Merrill Lynch. The S&P 500 Index is considered generally representative of the market for U.S. stocks; the BofA ML All U.S. Convertible Index is considered generally representative of the U.S. convertible market; the Barclays Government/Credit Index is a measure of the U.S. government and corporate bond market. Indexes are unmanaged, do not include fees or expenses and are not available for direct investment.
John P. Calamos, Sr. is Chairman, CEO and Global Co-CIO of Calamos Investments, a firm he founded in 1977.