As wealth managers seek predictable returns and ways to preserve capital in times of uncertainty, some may want to look beyond asset allocation and modern portfolio theory and consider convertibles.
At the Morningstar Investor Conference in Chicago on Thursday, June 24, fund manager and author John Calamos described the low-volatility investment strategies he uses. He compared the investing environment today to the one in the 1970s, when he began investing in convertibles.
Calamos, who said convertibles "do well in volatile sideways markets" like this one, cited legendary investor Warren Buffett as one who often uses a convertible structure in his own investing, calling it a "warrants and preferred stock equal convertible structure."
The chairman, CEO, and co-chief investment officer of Calamos Asset Management, which he founded in 1977, Calamos has written two books on convertibles strategies, quipping at the conference that they are "the kind of book, once you put down you can't pick up." They are Investing in Convertible Securities: Your Complete Guide to the Risks and Rewards (Longman Financial Service, August 1988) and Convertible Securities: The Latest Instruments, Portfolio Strategies, and Valuation Analysis (McGraw-Hill; 2nd edition, June 1998).
A convertible is a bond that is usually subordinated debt of a public company, with a coupon and maturity date. When the company's underlying stock hits a conversion price, the bondholder can opt to convert the bond for equity in the company.
For companies, Calamos said, a convertible "lowers the cost of debt," as well as the "cost of equity." Financing with convertibles can shave 2% to 3% off of the interest costs to a company for a regular corporate bond.
Calamos explained that investing in convertibles, as he does with Calamos Global Opportunities and Calamos U.S. Opportunities, can be considered core rather than alternative holdings. He says the strategy earns less on the upside, but also performs better in down markets than large-cap equity strategies. For instance, for the 10 years ended May 31, cumulative performance of the S&P 500 "was down 7.86%, while the Calamos Convertible Strategy was up 53.92%; Calamos U.S. Opportunities was up 89.95%, while Calamos Global was up 78.67%."
In the recent very volatile period between January 2007 and March 2010, Calamos said, "capital was preserved" in his strategies, with the U.S. Opportunities up 1.03% and Global Opportunities up 1.02%.
For his strategies, Calamos uses a model with which he values convertibles to decide which ones to buy. Most of his buys are investment grade, and he doesn't use leverage in the portfolios. The convertibles market globally is "small" at $600 billion, but he diversifies the portfolio, sometimes using synthetic convertibles to represent "five favorite [company] names," as well as "sectors that are not represented in the market." But he limits synthetics to 10% to 15% of the portfolio. Fees for his funds are in the "middle of the pack."
Comments? Please send them to email@example.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.