When we look at different strategies or market segments, I'll often say something like I want this to work but... and of course the point that matters comes after the but. And frequently the but is that it doesn't really work as hoped for or maybe the return is good but some purported diversification benefit doesn't quite deliver. Part of the process for me is to explore ideas and not give up trying to learn more about an idea because with more enlightenment and more study maybe something can make it's way into the portfolio.
A convertible bond fund popped up the other day that I wanted to dig in on. We've looked at convertibles several times in the past. I used one fund before the financial crisis that did well until the crisis and then it got hit hard along with the whole space.
Convertibles are more like equity proxies. They are often sold as being like equities on the way up and like bonds on the way down. There is a good amount of equity upcapture, yes, but there is also track record for more equity down capture than you might hope for.
The fund in question is the Virtus Convertible Fund. If nothing else, kudos for a name that isn't a word salad and of course there's a bunch of symbols, the institutional one relevant for advisors is ANNPX.The fund is highly rated and sure enough, the upcapture/downcapture is easily found. It captures 82% of equities' upside and 70% of the downside. Maybe we should revisit converts as a proxy for low volatility equity exposure.
Portfolio 1 here is 80% ANNPX, 10% ASFYX for managed futures and 10% BTAL. Both ASFYX and BTAL are client and personal holdings. Portfolio 2 is 80% Vanguard S&P 500 (VOO) with the same two alts and Portfolio 3 is 80% iShares US Minimum Volatility ETF (USMV) with the same two alts.
The CAGR is certainly in the neighborhood of USMV. The claim of 0.7% downside volatility versus the S&P 500 doesn't pan out for the period studied but the above was shorter than what was cited in the fund's literature. That claim is at least directionally correct, so ok, there is at least a little merit to the idea. I would then want to know if something was skewing the results. Maybe so.
In 2020, the convertible bond space skyrocketed. ANNPX was not left out, it was up 55%.
VOO and USMV did better in the shorter period. The portfolio with ANNPX, nudged up slightly but the standard deviation came down by a lot. The low volatility thesis still stands up. I tried to find why convertibles were up so much in 2020 without much luck. Here's a report from Morgan Stanley from back then that tries to explain why 2020 was so good. The report doesn't really explain the outsized move so much as describe what should be favorable market conditions for convertibles. Even though Morgan was calling for more of the same in 2021 convertibles lagged far far behind equities. The space was up, but modestly, nowhere near what equities did.
The next thing I would want to check is to compare it to covered call funds.
The chart takes out the 2020 skew and I just compared it straight up to the S&P 500 and XYLD which is a widely held covered call fund. I also looked at a couple of other actively managed covered call funds that have been around for a while, in those instances ANNPX outperformed by a noticeable amount and although it had a lower standard deviation than XYLD, it had a higher standard deviation than the actively managed covered call funds.
The last nit to pick relates to how well ANNPX has done versus some other funds that I know about, the SPDR Convertible Bond ETF (CWB) and the Calamos Convertible (CICVX). Neither has been close to ANNPX and so the concern is not being able to maintain such a wide lead against the convertible space. It didn't take long though to find a couple of funds I've never heard of that have similar return and volatility profiles.
That data goes back to 2009.
A few posts back we talked about tracking error. Over the longer term, these funds do track the S&P 500 for the most part even if not completely but year to year, there can be serious tracking error.
Going 80% into one of these is not something I would ever do, it's just easy for modeling and study, but as you look at the year by year, it is important to realize that in some years, a portfolio with a heavy allocation to converts (you can define heavy for yourself) is going to lag by a lot. Would you be ok in a year like 2014 when ANNPX was only up about half of what the S&P 500 was up or 2021 where the disparity was much greater? If you think of this as an alt, then anything you might ever do in this space needs to be sized properly.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
No comments:
Post a Comment