Convertible securities are similar to stock options, except they have yield—and almost never lose all your money (unlike speculative options). Their “special switch” feature lets you buy shares of the issuing company’s stock at a predetermined price.
Here’s more on the hybrid securities, from Grant Wasylik and Tom Dyson in The Palm Beach Letter:
I (Grant) spoke with a portfolio manager friend who manages over $2.5 billion in convertibles. He’s been doing it for 30 years. He calls them “chameleons” because they adapt to the markets.
Convertibles can work in good times and bad. And they offer a smoother ride than equities. That’s because you’ll earn income no matter what the underlying stock does…
Even in a market correction or bear market… convertible investors get paid with interest. They essentially get paid to wait for the next market recovery or bull market.
Now, convertibles aren’t completely risk-free. Bonds, like stocks, can also decline in value. But convertibles provide investors with significant downside protection…
Historically, they’ve only participated in 30-50% of the downside of their underlying equity… but they’ve enjoyed 60-70% of the upside.
That’s because a convertible moves more slowly than its underlying stock. It will rise more on a gain in the underlying stock than it will fall on a decline. This allows for “asymmetric returns”—which is why superstar investors love them.
Studies also show that convertibles can even outperform stocks.
Take a look at the following chart…
Notice the blue line (convertibles index) is above the pink line (S&P 500 Index) for almost 40 years. Convertibles have captured 81% of the upside of the equity market over the last 41 years.
Also, convertibles beat corporate and government bonds by 177%.
Here’s a real-life example of a convertible’s upside one of my investment manager contacts gave me…
We’ll use the Gilead Sciences Inc. 1.625% convertible bond, due 5/1/2016. If you purchased this convertible bond at par ($100) on 7/26/2010, you would have seen a return of 321.1% through 12/31/14.
The stock (GILD) returned 464.4% over the same time.
As a convertible owner, you got 70% of the stock’s return.
Even while the stock was bouncing around, you collected four years of interest payments. Plus you had sleep-at-night comfort knowing that you owned a bond at the end of the day. It’s why Buffett and institutional investors love these securities: They’re like a convertible car. Investors get to put the top down on warm, sunny days… but they can quickly put the top back up when the weather turns stormy.
From Grant Wasylik at The Palm Beach Letter: The most expensive ticket sold at face value for Super Bowl No. 1 in Los Angeles (1967) was $12. The most expensive ticket for Super Bowl No. 49 in Arizona (2015) was $1,900.
The increase in Super Bowl face value ticket prices from $12 in 1967 to $1,900 in 2015 is equal to +11.1% compounded per year for 48 years. Over the same time, the S&P 500 Index has gained +10.3% per year on a total return basis.
Reeves’ note: Most people would agree that the rise in Super Bowl ticket prices is absurd—how much more value has been added to a ticket over the years? In the end, you still get to watch a 60-minute football game.
But if you’d invested that money in the S&P 500, you’d own the 500 most powerful American companies—innovating, growing, and compounding your wealth. I don’t know about you, but I’d pass on the game… and its lame halftime show.