Sun Shines Bright on Convertible Funds

One method for detecting where a convert fund manager falls on this spectrum is to look at a fund's current yield.

For example, the current yield on the relatively new (GRVAX Quote)Gartmore Convertible fund is 3.3%, which is 30 basis points higher than the Morningstar average for convert funds. Jerry O'Grady, the fund's co-manager, says he prefers to be slightly conservative in his management, thereby foregoing some of the upside from the equity to maintain a higher yield. (Remember that a higher yield on a bond means a lower price, which ultimately pushes it further away from the conversion price.)

Silverstein's MainStay fund, on the other hand, offers a little lower-than-average yield of 2.6%, sacrificing a wee bit of downside protection in exchange for additional upside.

Current yield is a good starting point for comparing funds, but it by no means offers a complete picture due to the many moving parts involved with converts. For instance, some fund managers hold more straight equity than others, thereby lowering a fund's total yield. Others choose to hold higher-quality bonds, which also would lead to a lower current yield. (Companies in better financial health don't need to pay as high a coupon to compensate investors for the risk they'll default.)

O'Boyle says the important thing for investors to keep in mind when evaluating convert funds is to make sure the manager remains "true to the asset class" by not moving too far in either direction along the stock/bond spectrum. He also advises investors to seek out fund managers with the most experience in this tricky asset class.

Gartmore's O'Grady says convert funds should play an important role in an investor's asset allocation, but they often are neglected by financial advisers who are unaware of their benefits.

"Financial planners often struggle when they allocate their clients' assets between stocks and bonds," says O'Grady. "The smart ones realize that a good convert fund can fill the gap between the two very nicely."