TAKING STOCK: Convertible bonds

Dear Mr. Berko: Please tell me what a convertible bond is and why so few brokers recommend convertible bonds. I'd like to invest a portion of my portfolio in convertible bonds but don't know where to find research on these strange securities. What do you think of Value Line convertible research? Do you have any suggestions for me? -LK, Oklahoma City Dear LK: The first mention of convertible security in history dates back to imperial Rome. Regulus Cheatus owned the largest toga company in Rome. Its popular shares traded at 3 siliques on the Roman Pantheon Exchange. Regulus needed additional capital to market a double-breasted toga, and Bankus Takeus was offering to lend 1,000 talents (a lot of money) at 5 percent interest for 20 years. Regulus said that was too high and wanted Bankus to charge 3 percent. However, to compensate for the lower rate, Bankus would be allowed to purchase 1,000 Toga shares at 4 siliques anytime during the next 20 years and would also get its 1,000 talents back at maturity. Some say a convertible security offers the best of both worlds-the income and safety of a bond plus the appreciation potential of a common stock. However, during the past 10 years, these investments haven't set the world on fire. And most big-name convertible funds (Putnam, Pimco, MainStay, Lord Abbett and Columbia) barely have earned 6 percent total returns in the past decade. Though, Fidelity's convertible fund posted a 7.46 percent average 10-year total return, and I could live with that. Some of the best convertible research derives from Barclays and Credit Suisse. They've published dozens of recommendations that over the past decade have had outstanding results. Their research is thorough and clear. Merrill Lynch and Morgan Stanley have convertible bond researchers who are worth their weight in diamonds. Their narratives and conclusions tend to be too technical for my tastes, but the proof is in the pudding-and their pudding has been tasty. Value Line also has a convertible bond research department. Its recommendations are not widely respected by the industry and have few followers. I suspect that the Value Line staff is mostly composed of pubescent kids in short pants riding trikes with training wheels and hoping for an invitation to the big leagues. Value Line doesn't publish publicly, so I've never seen any of its recommendations. I know of no praise for its work, so I suspect that the Value Line dudes are duds. But their reports on common stocks are well-composed and above average for content and clarity. Most brokers won't mess with converts for four reasons: 1) The market is thin, and fewer than 700 issues are traded. There's just $163 billion in convertible issues outstanding. So by comparison, the $320 billion market cap of Microsoft is twice as big as the entire convertible market. So there's not much profit in this sector for the brokerage industry. 2) Therefore, the spreads between trades are huge, and clients are easily ripped off. Lehman Brothers had a convertible trader called "Jock the Ripper" for obvious reasons. Advest had a convertible trader we called "Mack the Knife" because he'd cut your client's heart out every time you placed a trade. 3) Investing in convertibles is significantly more complicated than stocks and requires a fairly strong math background. Unfortunately, 50 percent of brokers are below average, leaving out half the industry, and 48 percent of the remaining 50 percent prefer to peddle variable and indexed annuities or load mutual funds. 4) Most attractive convertible bonds are traded in the helter-skelter over-the-counter market, where it's difficult to find universal ticker/trading symbols that provide current data and prices. It's like being an American in a Yemeni bazaar; they see you coming. If you must own converts, consider looking at some of the closed-end convertible bond funds, such as Advent Claymore (AVK-$18.50), Bancroft (BCV-$19.86), Calamos (CHI-$13.87), Gabelli (GCV-$6.36) and AllianzGI (NIE-$19.86). None has an impressive record, but a peek at their portfolios may give you a good idea of what would be available in the market if you were to decide to invest in individual issues. -------- Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com. © Copyright 2014 Creators.com Published: Tue, Jul 01, 2014