Upside potential with convertible bonds
Why are convertible bonds worth considering? Convertible bonds have the potential for higher rates while providing investors with income on a regular basis. Consider the following: 1. Convertible bonds offer regular interest payments, like regular bonds.
2. Downturns in this investment category have not been as dramatic as in other investment categories.
3. If the bond’s underlying stock does decline in value, the minimum value of your investment will be equal to the value of a high yield bond. In short, the downside risk is a lot less than investing in the common stock directly. However, investors who purchase after a significant price appreciation should realize that the bond is “trading-off-the-common” which means they are no longer valued like a bond but rather like a stock. Therefore, the price could fluctuate significantly. The value of the bond is derived from the value of the underlying stock, and thus a decline in the value of the stock will also cause the bond to decline in value until it hits a floor that is the value of a traditional bond without the conversion.
4. If the value of the underlying stock increases, bond investors can convert their bond holdings into stock and participate in the growth of the company.
During the past five years, convertible bonds have generated superior returns compared to more conservative bonds. Convertible bonds have generated higher returns because many companies have improved their financial performance and have their stocks appreciate in value.
Convertible bonds can play an important role in a well-diversified investment portfolio for both conservative and aggressive investors. Many mutual funds will invest a portion of their investments in convertible bonds, but no fund invests solely in convertible bonds. Investors who want to invest directly could consider a convertible bond from some of the largest companies in the world.