A Convertible Fund for the Risk-Averse

If you’re feeling skittish about this never-say-die bull market but you’re worried about missing out on future stock gains, here’s an idea: Take convertibles for a spin. These hybrid securities combine elements of bonds (or preferred stocks) and common stocks.

To keep things simple, we’ll focus on convertible bonds. They pay interest at a fixed rate and mature at face value. But investors have the option to exchange their bonds for a predetermined number of shares of the issuer’s stock. Whether it makes sense to convert depends on the stock’s price. A key element of convertible-bond behavior is that the bonds tend to trade like stocks if shares of the issuer trade at a high-enough price for conversion to make sense. But if the stock’s price is well below the level at which the investor wins by converting, the convert will trade more like a regular bond, reacting heavily to swings in interest rates.

Convertible returns are “asymmetrical,” says Al Kurtz, comanager of Lord Abbett Convertible Fund (symbol LACFX), a top performer in the group. By that, he means the bonds tend to track share prices more closely in a rising market than they do when stocks are sinking. So he and his team add more-stocklike convertibles when they’re bullish on stocks and focus on converts that are more likely to trade like bonds when they’re cautious about the market.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Balanced approach. The fund typically holds about two-thirds of its assets in stocklike converts. The managers boosted their allocation to such bonds last year, snapping up issues whose underlying stocks they believed were undervalued because of concerns about the election. They’ve since sold some of their most stock-sensitive converts in favor of safer bonds. The fund’s sector weightings also reflect a “more balanced approach,” says Kurtz. At last check, defensive health care and utility bonds accounted for the largest chunks of the portfolio, followed by converts issued by industrial companies and retailers, two more-volatile sectors.

The fund’s Class A shares, which yield 1.4%, levy a 2.25% sales charge, but they are available without a load at several online brokers.