NEW YORK – It's a stock. It's a bond. It's both — and you have to pay for the privilege.
Convertible bonds, which pay less interest than typical corporate bonds but can be exchanged for a company's stock, are a niche that supposedly gives the investor the benefits of an upswing in the stock market with fewer risks on the downside.
For a company with a shaky credit rating, from just below investment grade to real junk, convertibles are a way to borrow money at a discount and sell shares at a premium.
Their coupon rates are sometimes half as much as an equivalent bond that isn't convertible. For that you get the right to exchange your bond for a set number of the company's shares. But that comes with a premium too. The price you'll pay for the stock can be anywhere from 20% to 300% or even more above market value.
Sound like a bum deal? Maybe not. If the stock is in the basement and then soars, you'll do well. If not, you still reap the coupon and par value.
Overall, the convertible funds that Morningstar tracks are up an average of 5.6% for the year.
Although convertibles behave more like bonds when the share price is far below the conversion price, most investors pursue convertibles as they would a stock.
Thomas Soviero, who took over Fidelity's Convertible Securities fund (FCVSX) last June, looks at convertibles as "company stocks I like that happen to have coupons attached." His fund is up 8.4% so far this year.
"The idea of a convert is you're buying an equity but waiting to see when you get paid," he says.
Stan Richelson, a financial planner with Scarsdale Investment Group in Blue Bell, Pa., specializes in bond portfolios.
From his standpoint, he remarks, "They're never a deal, they're really an equity play." As bonds they're "weak issues that need to put in that feature [convertibility] to sell their stuff."
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