NEW YORK (TheStreet) -- Edward Silverstein, manager of the MainStay Convertible Bond Fund (MCOAX) - Get MainStay MacKay Convertible A Report, says Teva Pharmaceutical Industries' (TEVA) - Get Teva Pharmaceutical Industries Ltd. Report cheap shares and strong cash flow makes its convertible bonds a strong bet.
The $717 million fund, which has earned four stars from
, has gained 45% during the past year, beating two-third of competing funds. The fund has gained 5.1% annually, on average, during the past five years, outpacing 96% of its Morningstar rivals.
Fund Manager Five Spot, where America's top mutual fund managers share their investing views in five fast and furious questions.
What is your outlook for the economy?
As spring follows winter, the economy will strengthen from its slump. The excessive leverage and speculation that caused the 2008 panic have diminished. Asset prices are returning to rational economic levels. Housing prices in the worst-hit real estate markets, such as Arizona, Las Vegas and inland California, have begun to rise. Other markets will follow suit once prices reach a level where it makes economic sense to own.
While employers continue to shed jobs, they are doing so at a decreasing rate. Existing employees are working an increasing number of hours and, in time, employers will substitute additional workers for overtime. U.S. gross domestic product has begun its expansion, as has consumer spending, albeit at a muted pace.
Why are convertibles a good way to play this market?
Convertible bonds inherently offer downside protection similar to some fixed-income investments and the upside participation related to stocks. Having appreciated over 60% since their March low point, stocks are vulnerable to selloffs despite positive economic underpinnings. Convertible bonds should hold up well relative to stocks during market selloffs.
Convertibles also provide investors with most of the stock market's rise should the upward trend of equities continue. During the past two decades, convertible bonds have outperformed stocks not only on a risk-adjusted basis, but on an absolute basis as well.
What are some of your favorite bond issues?
We like Teva Pharmaceutical's puttable bonds due February 2011 and
bonds due October 2010. These bonds offer significant potential upside tied to the performance of the issuer's equity and a fair level of downside protection in the event of a stock decline. Teva bonds are rated investment grade and although Core Labs' bonds are unrated, the company has more cash than debt and likely would be investment grade if rated.
Teva is the world's largest generic pharmaceutical manufacturer and also sells the world's leading treatment for multiple sclerosis. Teva's common stock is particularly attractive as it sells for less than 13 times 2010 earnings estimates, below historical norms. In addition, the company generates a significant amount of free cash, which can be used for acquisitions, share repurchases and dividend increases. Generics are likely to benefit from continued efforts to contain health care costs and additionally, patent expiration on multibillion branded drugs such as Lipitor should benefit Teva's sales and profits.
Core Laboratories offers reservoir analysis services to oil and gas exploration and production companies. Core Labs should benefit from increased spending on exploration activity due in part to increased commodity prices. The company is generating excess cash flow and recently raised its common dividend 20%. As with Teva, the convertible bonds of Core Laboratories are an attractive way to participate in the upside of the company's common stock.
What type of bonds do you avoid?
Given the tremendous tightening of credit spreads that occurred in 2009, we would avoid so-called busted convertible bonds, which offer a higher-than-average yield, but offer little in the way of participation in the common stock of the issuer. Yields on most of these bonds are no longer compelling and bond prices could be pressured if interest rates rise due to the strengthening economy.
What should we expect from convertible bond issuance and demand this year?
As a relatively small $220 billion market, the asset class could certainly benefit from new bond issuance. For the month of January, new issuance was just over $1 billion. Unfortunately, bonds that were either put back to issuers, called by issuers or matured was also just over $1 billion. Hopefully, convertible bond issuance will increase as companies need to raise capital to retire bonds set to mature in 2010. Given how well convertible bonds performed in 2010, most new issues should be well-received by investors.
Reported by Gregg Greenberg in New York
Before joining TheStreet.com, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.