Are Convertible Bonds The Holy Grail?

Finomial took a look at the potential diversification benefits of convertible bonds, hat tip Abnormal Returns for the link. We've looked at these a couple of times over the years, back in the 2000's I accessed the space through a closed end fund that had a high yield, higher than what the space typically offers, thanks to the leverage inherent in the closed end universe. If you've ever looked at this space you may have read that on the way up they look like stocks but on the way down they look more like bonds. 

That theory makes sense but it doesn't seem to play out in reality. Maybe though it could be some sort of low volatility equity proxy. Most of the gain with noticeably less volatility would be worth exploring.

 

CWB is the oldest convertible bond ETF. It is certainly in the neighborhood of USMV and the S&P 500 but does not compare favorably. It has a lower standard deviation than the S&P 500 which I would expect but has a higher standard deviation than USMV and a lower CAGR.

Now let's see if CWB, as a proxy for the space, can sub in for equities into the types of portfolios we've been experimenting with here where we use alts instead of traditional fixed income to offset equity volatility. I built the following to compare to the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio. BTAL is a client and personal holding.

And the results. 

Again, use of CWB gets you in the neighborhood. The CWB portfolio has the lowest standard deviation without giving up too much return to VBAIX but building the same portfolio with plain vanilla equity instead gives 169 basis points of extra CAGR with 93 more basis points of standard deviation.

The initial verdict for me is converts are not terrible but don't really give much diversification benefit and does nothing miraculous in terms of portfolio volatility. 

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