The High Cost of Owning Convertible and High-Yield Bonds in One Fund

Putnam Convertible Opportunities and Income Trust has a 1.71% expense ratio, highest by far in its category.
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I bought Putnam Convertible Opportunities and Income Trust (PCV) , a closed-end fund, because it gives me exposure to both high-yield and convertible bonds in one investment. But after reading the annual report, I found that the expense ratio is 1.71%. I had hoped for an expense ratio of closer to 1%. Of course I should have checked that before I bought it! I still like it for the yield, currently 7.85%. Is 1.71% high for this kind of fund? -- Bruce Koopmans

Bruce,

Yes, that expense ratio is quite high. In fact, it's hands down the highest expense ratio among convertible closed-end funds, which is how

Lipper

classifies your fund.

But your question is complicated because your fund, and another Putnam fund that also combines convertible and high-yield bonds in a single product,

Putnam High Income Convertible and Bond

(PCF) - Get Report

, seem to be the only closed-end funds of this type. The seven other funds in the Lipper category all focus pretty exclusively on convertibles.

You say you bought the fund because you wanted exposure to convertible and high-yield bonds in a single product. If you're going to insist on a single product, PCV is your fund. But you're paying through the nose for it.

Maybe you'd be happier in PCF. It has a much lower expense ratio of 1.03%. The biggest differences between the two funds are as follows: PCV strives for capital appreciation and income, can invest entirely in high-yield bonds and can invest up to 15% of its assets in foreign securities. PCF strives mainly for high income. High-yield bonds make up between 60% and 70% of the portfolio at all times. Also, PCV can use leverage; PCF can't. Leverage can enhance a fund's performance, but it can also magnify its losses.

PCF's long-term performance isn't as good as PCV's, however. Over the three years ended Dec. 18, PCV returned 8.37% a year on a net-asset-value basis, while PCF returned 8.02%, according to Lipper. (On a market basis, which takes share price changes into account, the returns were higher: 14.22% a year and 10.77% a year, respectively.)

You also might consider selling PCV and buying a combination of a straight convertible fund and a straight high-yield fund with more reasonable expense ratios.

Have a look at these numbers. You're paying 1.71%. The category average is 1.12%, and the category median is 1.06%. The lowest expense ratio in the category is 0.76%. The next highest expense ratio in the category after PCV's is 1.19% -- 52 basis points less than you're paying!

Putnam declined comment.

Maybe some funds can justify high expense ratios with out-of-sight performance, but not this one in its fairly short life (it started trading in June 1995).

Looking at NAV returns, which tell you how the fund manager is doing (as opposed to market returns, which mix the share price into the equation), PCV is down 5.17% for the year, more than all but one of its peers. Granted, the fact that it invests in high-yield bonds, which tanked this year, was a major handicap. But the fund didn't really distinguish itself before this year either (hard to do when the fund company is charging so much). During the three years ended Dec. 31, 1997, it returned 33.21% to rank fifth of the nine funds in the category. (PCF ranked seventh, returning 30.36%.)

Because of the holidays, Elizabeth Roy is answering your bond questions this week on Monday and Wednesday. Dagen McDowell will answer fund questions on Tuesday and Thursday.

Next week, Fund Forum will return to its normal schedule: Dagen McDowell answers your fund questions Monday through Thursday. Elizabeth Roy answers your bond questions on Friday. Send questions on either topic to

fundforum@thestreet.com, and please include your full name.