Are Convertibles A Magic Portfolio Solution?

There are a few topics that Barron's just loves to write about. That's not a knock, there are subjects I love to write about, I bet just about every blogger has topics that just love to write about. With Barron's, they write frequently about closed end funds, preferred stocks and convertible bonds. This week, they wrote about two of those, including convertibles. 

We've looked at converts a few times over the years, this summer we wrote a few times about convertible arbitrage as an alternative fund strategy falling into the category of horizontal line that hopefully tilts upward. But this post is just about convertible bonds themselves. Very simply, converts trade like bonds until the stock price gets near the point of making the bond convertible into stock. Ideally these look like stocks on the way up and bonds on the way down. Where 2022 has been a rough year for bonds, convertibles have not been spared.

The standard bearer for convertible bonds is probably the SPDR Bloomberg Convertible Securities ETF (CWB) which has $4.4 billion in AUM.  

So look like stocks on the way up, act like bonds on the way down? That's interesting. Does that actually work in practice though? If it does then could it be part of the conversation we had the other day about game over strategies?

Here's CWB compared to a couple of other funds we've looked at recently as possible game over funds and Vanguard Balanced Income Fund (VBAIX) which is a proxy for a 60/40 portfolio.

 

CWB appears to have more equity beta than either PUTW and VAMO. To be clear, PUTW and VAMO are completely different strategies. They are not comparable funds versus each other but what we're trying to explore is whether or not some sort of game over portfolio can be constructed with any of these. That chart gives a good idea of the pounding CWB has taken in the bond bear market. 

In terms of numbers comparing CWB, PUTW and VAMO;

 

Same stats for the S&P 500 and VBAIX.

 

The best year for CWB which was in 2020 skews the CAGR to 9.82 which might have a tough time repeating. The max drawdown for CWB looks like VBAIX.

I think this comparison makes the most sense for what we're learning about CWB and keeping in line with what we've been talking about for months using LOTIX which is a manged futures fund.

 

And the results;

The CWB portfolio lands in between SPY and VBAIX. The worst year and max drawdown numbers are compelling but that 9.54 CAGR for the CWB portfolio is misleading for the reason stated above. Smoothing out that 53% lift for CWB in 2020 would bring the CAGR down closer to VBAIX but with a higher standard deviation than VBAIX and as we've seen this year, CWB is not immune to interest rate risk. The reason the CWB portfolio has done so well this year, down only 2%, is because of the allocation to managed futures.  

Convertibles might makes sense to allocate to in a small slice, or not, that's up to you, but I don't think it fits the bill for a large allocation in a game over portfolio. 

I have no interest or intention of using any of the funds mentioned in this blog post personally or for clients.