Advent Capital Management sees the future, and it is in closed end funds specializing in convertible bonds.
As the market dips and dives, Advent is betting on a bigger and newly consolidated closed-end convertible bond fund will prove to be a winning draw for investors.
Advent recently merged three funds in the convertible bond space, rolling two smaller funds, AGC and LCM, into the now $1 billion Advent Claymore Convertible Securities and Income Fund, or (AVK) - Get Report .
Advent contends the larger, combined fund is hitting the market at just the right time, with investors typically seeking out convertible bonds in times of uncertainty.
Convertibles offer investors the chance to participate in the upside of a hot stock while having the fallback security of a lower-yielding but more secure bond.
Companies are on track to issue $43 billion in convertible bonds by the end of 2018, the most since 2008, The Wall Street Journal has reported, citing Dealogic.
Still, convertibles can have their downside as well. Often less credit-worthy companies offer convertible bonds as a relatively inexpensive way of raising money, effectively promising to cut investors in on the deal should their stock price rocket while also providing the security of a bond if it doesn't.
"The idea of convertibles is to win by not losing," says Tracy Maitland, president and chief investment officer of Advent. "Your downside risk is a 3% rate of return and that convertible bond is convertible into stock if the stock goes up."
A buying opportunity?
Maitland oversees more than $9 billion in institutional investor cash at Advent, working closely with public pensions, corporate pensions, insurers, endowments, foundations, as well as private individuals.
AVK is one of a number of investment vehicles overseen by Advent, with a focus on convertibles the common theme.
Advent has 60 employees, including 21 on the investment side, split between New York and London. There are eight sector analysts, with a focus on health care and high-tech, industries in which companies have relied on convertible bonds as a relatively inexpensive way of taking out debt.
On average, the sector analysts have 22 years of experience, Maitland said.
"They are not two years out of Columbia Business School," he said. "They have significant experience in their sectors and they have been following these companies year after year."
When evaluating convertible bonds, Advent's analysts "do a lot of credit work," drilling down into whether a company is truly generating cash.
"We don't care what a company makes," Maitland said. "Does it generate cash? What is the trend? If it is negative, is it becoming less negative? We have learned companies can make up reported earnings but it is little more difficult to make up cash in the bank."
Maitland sees a market ripe for convertibles - and in particular Advent's closed-end fund AVK - given the uncertainty about the direction of the global economy amid Brexit, the trade standoff between China and the United States, and the Federal Reserve Board's rate raising moves.
"It is a wonderful way to invest in a market that right now is experiencing volatility because of all these geopolitical issues and rising rates" Maitland said.
Maitland contends AVK's discount, now at over 14%, presents a buying opportunity for investors looking to buy convertibles.
Unique to fixed-capital structure of closed-end funds, discounts enable a buyer to snap up bonds and stocks in a fund's portfolio for pennies on the dollar. In the case of AVK, 86 cents will buy you a dollar's worth of convertible bonds. If the fund's price rebounds and the discount narrows, the investor earns a nice return. If it widens, then the bet can backfire.
After a closed-end fund issues shares through an IPO, the number of shares remains fixed and does not expand or contract based on market activity like it does with an open-end mutual fund or an ETF. This fixed-share structure means the price a closed-end fund trades at each day and the net asset value of its underlying portfolio float independently of each other, often creating discount situations.
"Basically you are buying $100 worth of stuff for 86 bucks - we love discounts," said Ken Nuttall, director of financial planning BlackDiamond Wealth Management in New York and a certified financial planner. "It usually trades in the 5-7 % (discount) range."
In AVK's case, the wider discount is not due to any inherent issues with closed-end fund's portfolio, but instead reflects its recent merger with two smaller funds, Maitland said. The fund's price was driven down by some selling by investors in the smaller funds who received AVK shares in the merger process. This has combined with typical, end of the year tax-loss harvesting sales to drive down AVK's price and widen its discount.
The result has been a wider discount than comparable closed-end convertible bond funds, he said.
Advent combined the three funds to save on administrative expenses and to create greater liquidity, Maitland said.
Still, Warren Warren Ward, a CFP who runs WWA Planning and Investments in Columbus, Ind ., offered a more cautious assessment, noting that the high discounts among closed-end convertible bond may also reflect a high degree of leverage and the "potential risk of capital loss if rates jump."
However, Maitland contends AVK's discount offers both a bargain and the promise of a nice return should the fund's price rebound and its discount narrow and move back into line with other similar closed-end funds.
Advent has bought stock in AVK as well as some of its board of directors.
"The merger of the three funds and institutional selling has caused a temporary opportunity," Maitland said. "We are putting our money where our mouth is."